Woodward, Inc. (WWD) Q2 2022 Earnings Report, Transcript and Summary

Thank you for standby. Welcome to the Woodward, Inc. Second Quarter Fiscal Year 2022 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. Mark Hartman, Chief Financial Officer; and Mr. Dan Provaznik, Director of Investor Relations. I would now like to turn the call over to Mr. Provaznik.

Thank you, operator. We'd like to welcome all of you to Woodward's second quarter fiscal year 2022 earnings call. In today's call, Tom will comment on our markets and related strategies, and Mark will discuss our financial results as outlined in our earnings release. At the end of the presentation, we will take questions. For those who have not seen today's earnings release, you can find it on our website at woodward.com. We have 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 through May 16, 2022 or on our website. 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'd like to refer to and highlight our cautionary statement as shown on Slide 3. As always, elements of this presentation are forward-looking or based on our current outlook and assumptions for the global economy and our businesses more specifically, including the expected and potential effects of the ongoing COVID-19 pandemic and net inflationary pressures. These elements can and do frequently change. Please consider our comments in light of the risks and uncertainties surrounding those elements, including the risks we identify in our filings. In addition, Woodward is providing certain non-U.S. GAAP financial measures. We direct your attention to the reconciliations of non-U.S. GAAP financial measures, which are included in today's slide presentation and our earnings release and related schedules. We believe this additional information - financial information will help in understanding our results. Also, all comparisons made during this call are to the same period of the prior year, unless otherwise stated. Turning to our results for the second quarter. Net sales for the second quarter of fiscal 2022 were $587 million compared to $581 million, an increase of 1%. Net earnings were $48 million or $0.74 per share compared to $68 million or $1.04 per share. Adjusted net earnings for the second quarter of fiscal 2022 were $47 million or $0.72 per share. There were no adjustments to earnings in the prior fiscal year second quarter. Net cash provided by operating activities for the first half of fiscal 2022 was $50 million compared to $219 million. Free cash flow was $26 million for the first half of fiscal 2022 compared to $206 million, and adjusted free cash flow was $27 million for the first half of fiscal 2022. Before we turn the call over to Tom to comment further on our results, strategies and markets. Mark would like to make a brief comment.

Thanks, Dan. As you may have heard, Tom recently announced his retirement from Woodward after more than 31 years with the company. This will be his last earnings call as Chairman and CEO. Tom, on behalf of all members and the Woodward Board of Directors, I wanted to thank you for everything you have done for this company. For the past 17 years, your visionary leadership piloted Woodward towards the future, expanding our market capitalization from under $700 million back in 2005 to approximately $7 billion today. The strategy set in place in the early 2000 enable us to achieve extraordinary growth and created significant value for our shareholders. These tremendous accomplishments will be remembered for many years to come. For that, we all thank you. We wish you and Tracy, the best of luck in the next phase of your journey.

Thank you, Mark. I appreciate the nice comments. It has been an honor and a privilege to lead this special company over the past 17 years. We have an outstanding team, the market-leading product portfolio, innovative technology, state-of-the-art facilities and an exciting future full of opportunities. I'm confident the Board's selection of Chip Blankenship as my successor and know I'm leaving the company in very capable hands. I look forward to working with Chip as he transitions into his new role. Turning now to the second quarter. Orders are up in nearly all market segments, our backlog has grown and we continue to see strong signs of recovery across the business. However, in the quarter and looking to the remainder of the fiscal year, we anticipate ongoing market volatility due to industry-wide COVID-19-related disruptions, including global supply chain challenges and labor shortages as well as the lockdowns in China and the war in Ukraine. In addition, the second quarter was also negatively impacted by increasing inflationary pressures and labor inefficiencies from the onboarding of approximately 400 new direct members since the beginning of January. All of these factors weighed on our results in the second quarter and have impacted our full year outlook. Although we expect these challenges to persist through this fiscal year, we are encouraged by the momentum we are seeing across the business. It is now my view that we will not be able to meet our previous guidance. We have the orders, they are not lost, but with the challenges I noted, we are reducing our outlook for the fiscal year. Our long-term outlook remains the same as we see our markets continue to recover and our sole source positions are intact. Moving to our markets. Commercial Aerospace continues to recover, driven by rising passenger traffic and increased utilization of commercial aircraft fleets that include significantly higher Woodward content. U.S. and European domestic passenger traffic is nearly at pre-COVID levels while China domestic passenger traffic has recently collapsed as a result of further government-mandated lockdowns. International travel continues to improve. And overall, we expect aircraft build rates to slowly rise throughout the year. Despite general market recovery, the 737 MAX return to service in China continues to be delayed with new builds for Chinese airlines pushed to later this year. We continue to monitor the situation. In the defense market, geopolitical tensions have elevated the focus on defense spending around the world and increased spending is anticipated. However, we continue to expect the JDAM program to remain at lower levels for the foreseeable future. Turning to our industrial market. In power generation, demand for gas turbines continues to drive strong growth in Asia. Aftermarket activity has been increasing, and we continue to see strong demand for backup power for data centers. In transportation, demand for China natural gas trucks has nearly evaporated for the fiscal year. We believe the market will be slow to recover as lockdowns and elevated natural gas prices are impacting demand. The global marine market is strong with increasing ship build rates, higher utilization and elevated transport pricing, all of which drive current and future aftermarket activity. The oil and gas market is favorable as prices remain elevated, utilization and aftermarket demand has increased, which we anticipate will drive higher rig counts and additional capital investment. For Woodward, overall, we continue to expect further recovery and improved profitability in our Aerospace business as OEM build rates increase and passenger traffic recovers. Similarly, in our Industrial business, we anticipate improved profitability driven by continued growth in marine markets and increase in demand for industrial gas turbines and related services as well as growing customer investments in oil and gas supported by elevated prices. In summary, we believe our markets will continue to improve, enabling Woodward to achieve our long-term profitability goals. We are laser-focused on addressing the challenges of this market recovery while continuing to enhance operational excellence, delivering value to our shareholders and customers and positioning Woodward to capitalize on future market opportunities. Mark will now review our quarterly results and our revised fiscal year outlook.

Thank you, Tom. Net sales for the second quarter of fiscal 2022 were $587 million, an increase of 1%. Sales for the quarter were negatively impacted by approximately $100 million due to ongoing industry-wide COVID-19-related disruptions, including supply chain constraints and labor shortages. Aerospace segment sales for the second quarter of fiscal 2022 were $370 million, an increase of 2%. Segment sales were negatively impacted by approximately $60 million of industry-wide COVID-19-related disruptions, which resulted in shipment delays for some orders. Commercial OEM and commercial aftermarket sales were 21% and 40% higher, respectively, driven by continued recovery in both domestic and international passenger traffic and increasing aircraft utilization. Defense OEM sales were down 28% in the quarter primarily due to lower sales of guided weapons. Defense aftermarket sales were down 12%, primarily due to COVID-19-related disruptions. With the exception of guided weapons, our defense sales order backlog is increasing. Aerospace segment earnings for the second quarter of 2022 were $60 million or 16.0% of segment sales compared to $69 million or 18.9% of segment sales. The decrease in segment earnings was a result of net inflationary impacts, including material and labor cost increases as well as increases in manufacturing costs related to COVID-19 disruptions and inefficiencies related to hiring and training. We are taking pricing actions to offset inflationary pressures. However, timing can be delayed due to certain contractual arrangements. Turning to Industrial. Industrial segment sales for the second quarter of fiscal 2022 were $214 million compared to $217 million, a decrease of 1%. Segment sales were negatively impacted by approximately $40 million of industry-wide COVID-19-related disruptions, weakness in China natural gas engines and an $8 million unfavorable foreign currency impact, all partially offset by increased marine sales as we continue to see higher utilization of the in-service fleet. Industrial segment earnings for the second quarter of 2022 were $17 million, or 8.1% of segment sales compared to $28 million or 12.9% of segment sales. Industrial segment earnings decreased primarily as a result of net inflationary impacts including material and labor cost increases as well as increases in manufacturing costs related to COVID-19 disruptions and inefficiencies related to hiring and training. Similar to our aerospace business, we are taking pricing actions to offset inflationary pressures. However, timing can be delayed due to certain contractual arrangements. Nonsegment expenses were $15 million for the second quarter of 2022 compared to $10 million. Adjusted nonsegment expenses for the second quarter of 2022 were $17 million. There were no adjustments to nonsegment expenses for the second quarter of 2021. Adjusted nonsegment expenses for the second quarter of 2022 included a reversal of a charge associated with a nonrecurring matter unrelated to the ongoing operations of the business. The increase in nonsegment expenses was the result of timing of certain expenses as well as the return of annual variable incentive compensation costs. At the Woodward level, R&D costs for the second quarter of 2022 were $32 million or 5.5% of sales compared to $28 million or 4.8% of sales. SG&A expenses for the second quarter of 2022 and 2021 were both $44 million. The effective tax rate was 11.4% for the second quarter of 2022 compared to 13.0%. The adjusted effective tax rate for the second quarter of 2022 was 11.0%. There were no adjustments to the effective tax rate for the second quarter of 2021. Looking at cash flows. Net cash provided by operating activities for the first half of fiscal year 2022 was $50 million compared to $219 million. Capital expenditures were $24 million for the first half of 2022 compared to $13 million. Free cash flow was $26 million for the first half of fiscal 2022, compared to free cash flow of $206 million. Adjusted free cash flow was $27 million for the first half of 2022. Adjustments to free cash flow for the first half of this year included payments related to business development activities and restructuring activities. There were no adjustments to free cash flow in the prior year period. The decrease in free cash flow and adjusted free cash flow was primarily related to working capital increases to support the anticipated second half growth. Leverage was 1.8x EBITDA at the end of the second quarter. During the first half of fiscal 2022, $294 million was returned to stockholders in the form of $22 million of dividends and $272 million of repurchased shares. Year-to-date through April 30, 2022, approximately $400 million was returned to shareholders, $377 million in repurchase shares and $22 million in dividends. Lastly, turning to our fiscal 2022 outlook. COVID-related disruptions and net inflationary impacts during the second quarter of fiscal 2022 were greater than anticipated. Although improvement is expected through the remainder of the year, particularly related to the COVID-19-related supply chain disruptions, we have revised our fiscal year 2022 outlook. The revised outlook assumes the current inflationary environment does not significantly worsen. Total sales for 2022 are now expected to be between $2.40 billion and $2.55 billion. Aerospace sales growth percentage is still expected to be in the low double digits to mid-teens. Industrial sales growth percentage is now expected to be between 5% and 10%. The decline in industrial sales growth from the previous outlook is primarily driven by expected ongoing weakness in China natural gas engines due to the lockdowns in China and elevated natural gas prices as well as headwinds from foreign currency exchange rates. Aerospace segment earnings as a percent of segment net sales are now expected to be approximately 18%. Industrial segment earnings as a percent of segment net sales are now expected to be between 10% and 11%. The decline in both segments earnings as a percent of net sales from the previous outlook is primarily due to net inflationary impacts, including material and labor cost increases as well as increases in the manufacturing costs related to COVID-19 disruptions. The adjusted effective tax rate is now expected to be approximately 20%. Adjusted free cash flow is now expected to be approximately $200 million to $230 million. Adjusted free cash flow conversion rate is still expected to be greater than 100%. Also, capital expenditures are now expected to be approximately $60 million. The decline in adjusted free cash flow from the previous outlook is related primarily to the delayed timing of our sales and the resulting impact on our working capital balances. As the COVID-19 disruptions decline, we expect our working capital requirements to improve, thereby recovering the cash flow delayed from fiscal 2020 in fiscal 2023. Adjusted earnings per share is now expected to be between $3.20 and $3.60 based on approximately 64 million of fully diluted weighted average shares outstanding. The previous outlook assumed approximately 66 million of fully diluted weighted average shares outstanding, which would equate to adjusted earnings per share between $3.10 and $3.50. This concludes our comments on the business and results for the second quarter of 2022. Operator, we are now ready to open the call to questions.

[Operator Instructions] Our first question comes from the line of Robert Spingarn with Melius. Please go ahead.

And Tom, congratulations on your retirement and wish you the best. It's been great working with you.

Thank you. I appreciate that.

Just digging in here, unfortunately, a tough quarter. I wanted to ask you on your OE sales and commercial aero, you've said in the past, they've been profitable. Is that still the case with all these inflationary pressures and other factors?

Yes, Rob, I still see it as profitable. As Mark highlighted in the prepared comments, we will be offsetting inflation with price increases. Some of that comes through our long-term agreements, which have escalation provisions. Those contracts still have once per year price adjustments. And then - and that's - those are primarily all OE type agreements. The aftermarket, we are pushing through price increases. Some of that inflationary as we said, were supply chain. But if all of you guys remember at our Investor Day, we talked about having to hire quite a few people with the growth that was coming and some of the attrition we saw during COVID. To do that, we had to up our wage rates across the board. We will start to see recovery on that too, through escalation and through pricing. So it's a delayed recovery that we're going to see. So we still see a profitable OEM sales.

Okay. And then just another one on - just on shipset content. You tend to have higher content on the Boeing platforms relative to Airbus. And I don't know if that's the GE relationship. But given what's been happening at Boeing and some of the unforced errors there, do you see maybe a different mix going forward between the two airframers for Woodward?

Well, definitely, Airbus rates are going up. And one of the things that we show on content, you may be referring maybe the A320neo versus the MAX, we do have more content on the LEAP, but it's pretty much equivalent in A320neo with LEAP or a MAX with LEAP. We have slightly less content on the pure power on the neo. So that's where maybe...

Yes, I guess I was factoring in widebody too because there - that's with the GE relationship, Tom.

Sure. That's correct. We have better content on the widebodies at Boeing. So that's a correct statement. Yes, it's going to be - let me put it this way. I think over time, the 787, 777X are going to be good-selling aircraft. As everybody knows, they have some issues right now but those are two very good long-range aircraft, and they will pick up and be positive in the future, in my view. There was a time...

And that was the last part of my question, Tom, which is do the further delays on 87 and 777X, is that part of what changed here for this year? Or is that really - nothing to do with it?

Well, we saw a little - not on 777X, but we saw the traditional 777, yes, was down and the 87 was down. So that did impact a little bit, yes. But overall, we're seeing OEM rates in particular, narrow-bodies coming back up, and I think the 87 will come. So it did have an impact on us. But yes - but it wasn't a major part of it.

Our next question comes from Sheila Kahyaoglu with Jefferies. Please state your question.

Tom, congratulations on your retirement.

Thanks, Sheila. Yes.

I wanted to ask you several questions on Aerospace, if that's okay because you're always very forthcoming. When we think about aero, I think investors just kind of want to understand what's going on with inflation. How do we think about where inflation is the most risk? Is it on the OE side? Or is it aftermarket? How can we think about this abating because I think Mark mentioned in his prepared remarks, it's not considered for the remainder of the year? Can you talk a little bit about that?

Sure. Well, first, I would highlight, like I just mentioned before, we have internal Woodward labor rate inflation, and that was required to be able to attract and fill the 400 positions that we've hired since the beginning of the year. Those are all direct labor positions. So that hit. We have seen some pressure coming from suppliers. We've been - I'd say our supply chain group has been doing a good job trying to mitigate that, but there is some there. So it takes a little bit of time to recover that through our contracts and pricing, but we fully intend to recover that. The aftermarket, we have much more flexibility, as you know, and we will get those offsetting price increases to inflation in place. We already have done some, and we're going to be doing more. So I see that happening. The other one that kind of ties into - it's not really inflation, but we're ahead of plan on hiring direct labor. And if you recall, we said we were going to need to hire 100 per month. We've been with - our teams have been doing a good job getting people in. Some of that was required labor rate changes. But when we bring in that many people, we did have inefficiencies. So we don't put people directly on the manufacturing line. We put them through extensive training. That all goes into manufacturing overhead, which is a cost. And then the people aren't quite as efficient when they first get on the lines. We see that improving in the second half of the year. We expect labor efficiency to improve quite a bit. So that will be a natural part of the - what we're calling the inflationary and COVID disruptions. So we do believe we'll be able to recover the inflation. It's just delayed and we'll start to see in the second half of the year and on into '23.

So a follow-up to that, I guess, how much of the inflation is labor force related versus like freight and materials? And then my second question would be when we look at margins, they dropped almost 1,000 basis points from where they were in Q2 '20, granted that was a great quarter at 24.8% margins. But like how - what's that bridge in the margin drop?

Well, the margin dropped, definitely has some inflationary issues in there. It does have a mix issue, does have these labor efficiencies in there. I think you guys could all do the math, if you look second half of the year, we'll be increasing margins. You see that coming through. We anticipate that will start to recover some of the past due we have due to these disruptions. So you start seeing the margins on the volume increasing in the recovery in some of the COVID pressures. So I think that's where it lies on that one, Sheila. It's a combination of all of those.

Our next question comes from Peter Skibitski with Alembic Global. Please state your question.

Tom, I'll echo Rob and Sheila, best of luck in your retirement. One clarification on Aerospace, the $60 million COVID headwind, you talked about widebodies a little bit. Was that pretty much all defense aftermarket just because it sounds like the defense OEM was down almost all because of the kind of fundamental guided weapon softness, so was it mostly the aftermarket?

No. No, it's across - Mark, do you want to chime in?

Yes, it's across all four subsegments of aerospace. That $60 million impact did impact them all, commercial OEM market and defense OE aftermarket.

Okay. And do you - are there any - we've talked the last few quarters about some of your suppliers having, I guess, capacity issues because of the cutbacks that they did previously. What's the update with those? And maybe what's the update in terms of chip shortages.

Yes. No, great question. We're - we've got a lot of suppliers with the legacy products we have. So we've got a big tail of suppliers. But what we have is our high-risk suppliers, and we went through and we originally started with, I think, it was about 20. We've mitigated the risk on those. But as we're mitigating the risk on those, I think the list of troubled suppliers that are still impacting us is like 28. So that's out of about a couple of thousand suppliers. So those ones we're working. We've got recovery plans with them. We've got teams on site. We're addressing that. And the process and the approach we're using is yielding results. But it's still in the tight supply base we have, if you're looking at castings, forgings, machine houses, they're all struggling with labor and capacity recovery in their facilities. So those are some of them. And as we highlighted before, some of the supplier issues have been plant shutdowns, moving products during the - when the market was really shut down in 2020. So they're still recovering from some of those. Now on the semiconductors, that is still an issue for us, and it is impacting both aero and Industrial, but I would say it's impacting Industrial, a fair amount more than aero. And one of the issues we have there, and I think we might have said this at Investor Day, we use a lot of components or chips that are used in automotive. And we're low-volume, high-mix supplier. And that has been challenging due to the problems the auto guys are having getting source. And so we are working hard to get the semiconductors, but that's still ongoing pressure. And as we said before, full recovery, we don't see until '23, and it might be mid to late '23 as we get that back on track. So that's still a big challenge. The other ones we think we've got good mitigation plans that they take some time, and we'll start seeing recovery second half of this year. As Mark said in his prepared remarks, some of that will roll into fiscal year '23. None of the sales are lost. I just want to really emphasize that. There - on all these, we're generally 100% across the board, sole source. So it's a matter of getting recovery, helping our customers make sure we keep their lines running and getting back on track. So - that's the positive. It will come, and those sales will recover and the cash flow associated with those will come. Some of it's rolling into fiscal year '23, just due to that as we ship late in the fiscal year, that's going to end up in AR and that's going to roll into '23 to get the cash out.

Our next question comes from Christopher Glynn with Oppenheimer. Please state your question.

And Tom, thanks for all the insights, great insights on the aero sector over the years. I was curious about the formulation of the sales push up the $100 million. Is that kind of a rolling cumulative that built on the $70 million for the prior quarter? Or have we aggregated now a couple of hundred million of sales pushouts?

No, it's a rolling cumulative. So it's the equivalent of the $70 million at the end of Q1 is now $100 million, so it's grown $30 million since the end of Q1.

Okay. Great. And since it sounds like the hiring and training was a reasonably big rub and it's one of the nice swing factors in the second half as you described, the process of new talent becoming efficient. I'm curious, a couple of things. Are those kind of proportional impacts at both segments or tilted to one? And is the hiring kind of winding down, have you gotten the talent you need?

Yes. No, good question. It's a little bit tilted to aero, where we had faster line rate increases and - as well as aftermarket increases. We are actually ahead of our plan, which is good. And we will start to see that hiring slowing down in the second half and then going to more natural hiring practice of supporting the growth that we expect in '23 in covering attrition. But that will be more normal than what we've experienced in the second quarter and a little bit moving here in the third quarter. But we really have done a good job getting ahead of it, and that will start tapering off.

Okay. And as we think about the linearity of the back half and we've got your margin and revenue and EPS guidance, should we just kind of functionally stair step those right through kind of proportionately?

Well, I would tell you it's going to - if you say stair step, maybe you talk about it, it's going to be higher in the fourth quarter than the third quarter, okay, because just - so maybe that's the details of the guidance, I'll give you. It is very - it's back-end loaded. We - I just reemphasize, it's not a lack of orders. We have all the orders, so just getting the orders out and I anticipate it will be higher in the fourth quarter than the third quarter.

Our next question comes from David Strauss with Barclays. Please state your question.

I'll echo - congrats, Tom, best of luck. Wanted to ask, I guess you had your Investor Day, I think it was March 9, you reiterated the guidance that appeared to be very back-end loaded at that point. I guess what changed over the course of the next couple of weeks that you weren't anticipating at that point?

Yes. Look, if you really look, the lockdowns in China, the war in Ukraine broke out, we didn't call out. We were definitely impacted by sales that were going to go into Russia and Ukraine. As a matter of fact, some of those were ready to go, and we couldn't ship because we no longer could ship to Russia. Ukraine kind of take orders that's not that, that was major, but every $10 million plus adds up. China lockdown is impacting not just the what we call the on-highway natural gas, that - and we did use the term evaporated. I mean that's down to near nothing right now. And then other China sales have been delayed. So those are all differences that occurred between that Investor Day and today. And then just on top of still working through supplier issues. We haven't recovered as - candidly, we haven't recovered as quickly as we were believing we were, but it's all those factors together. But the China lockdown is still - again, we basically have removed a high, high percentage of our China sales from the forecast, just with the problems there. So that is a big difference, and we're still watching what will happen with Ukraine. So those are impactful things that occurred since our Investor Day.

That's great color. Just in terms of a reference point, China natural gas sales and, I guess, typical year, what were you anticipating out of that business this year versus what your - I guess, now that you begin to 0, what we're you anticipating?

Yes, just approximate, I'd just tell you, approximately it would have run maybe $40 million to $50 million a quarter, and we're down to near 0.

Okay. And then last one for me on MAX. MAX rates, can you talk about where you are today? Are you in line with what Boeing stated or maybe below - still below kind of those rates? Or are you actually seeing some bit of restocking there?

No. The rates are kind of - they're flowing through. So we're on track with that, and we're preparing to continue the ramp both what Boeing is looking at and what Airbus is looking at, so we're on track for - in following their guidance there.

Our next question comes from Michael Ciarmoli with Truist Securities. Please state your question.

Tom, all the best. It's been great working with you over the years. I guess, well, maybe first since David was asking about the MAX in rates. I mean, are you guys - can you guys keep up with production? I mean if we fast forward six months, 12 months, Airbus, obviously, still talking about where they want to get the narrow-bodies up to, I mean, are you guys becoming the long pole in the tent here? I mean is there any kind of risk on you guys being able to get product out the door that might threaten future deliveries?

Yes. No, we're not holding up any deliveries of Boeing or Airbus aircraft. We look out and plan our - well, let me back up first. We have the capital equipment necessary to produce at the highest rates that we believe Boeing and Airbus are going to go to. We've talked about that before, before COVID, we had capitalized in anticipation of those higher rates. The issue we had was labor, and we are on track now with the labor to deliver on those programs. And we have a very thorough what's called SIOP process where we look out 18 months, we plan our capacity, our labor, and we're on track to meet all that. So we know the growth rate, what we need in labor capacity, that translates into Woodward, but we're also working all of our suppliers to ensure that they are ramping and that work is in progress. And I'm highly confident we'll keep up with those increasing ramp rates, and we're capitalized to do it.

Got it. Got it. I mean, obviously, all the suppliers here are getting impacted, labor, inflation. I get the China nat-gas sales, so maybe setting that aside. I mean is there anything in your business that's making you a little bit more unique here that you're seeing these kind of outsized headwinds or anything you can kind of glean just from seeing your business?

Yes. I think one of the ones to think about - we have a wide range, if you want to call them, SKUs in the company. We've always said we're high mix, low volume. A few programs are mid-volume, but we have a lot of different lines that we support. And when you have lower volume, you are impacted more when you have small number of lower-volume suppliers. And I would say that's the case. And then the other part of that, which comes into play, and I mentioned that earlier here on the call, is we use a lot of automotive semi-grade semiconductors. And the reason for that is they're high temperature and they're reliable for - in our market. And we have a wide range of products with electronics in them. And that broad portfolio, I think, is maybe different than a few - than some other peer companies or the like. And with the volumes, that's what we kind of believe is part of the impact that we saw. And then yes, I guess that's what we believe is part of it.

Okay. No, that's helpful. And then just last one for me. On the aero aftermarket, it obviously sounds like you've got more pricing power there. Do you expect that you can pass through all of your costs and still get some, call it, real pricing, I guess? Or are you still - I'm just looking at that price-cost dynamic? Are you still going to maybe see some pressure there?

In the aftermarket, we can, yes. And on OE contracts, and as I highlighted before, the ones that are under long-term agreement, we have negotiated escalation clauses. So that's usually helps us recover inflation, not to go above inflation. Where we don't have any contracts, we have more flexibility, but most of our OE sales are under long-term agreements.

[Operator Instructions] Our next question comes from Matt Akers with Wells Fargo. Please state your question.

Tom, congratulations. Best of luck to you. I wanted to ask again on the China natural gas trucks. I don't know if this is possible to parse out, but how much of that impact do you think was from the lockdowns versus just higher natural gas prices. And it sounds like you've taken that almost completely out of the guidance. Is there any potential upside there if the lockdowns do starts to ease?

Yes. It's a little hard to say actually elevated natural gas prices harm the truck sales. The lockdowns have reduced demand, so I think it's a combo and it's a little hard to say which one was more than the other, but I think that combo is what really dried up the market. Yes, there would be upside if it recovers in the second half of the year to our forecast, that's a really hard one to predict. So that's also why we really took it out.

Yes, that makes sense. Okay. And then I guess on the aftermarket growth, was there any provisioning in that number? Or maybe if you could just talk about how big provisioning is contributing at this point, how that should sort of trend here going forward?

Yes. Provisioning is increasing right now. And you can see 40% commercial aftermarket sales growth. That growth rate was really on top of delays in deliveries of MAXs in China, and we do anticipate that, that held - or we do believe that held up some provisioning sales for those Chinese airlines. So we expect that to come as those planes start to get delivered. So - but initial provisioning is doing well as well as shop visits are up. And overall, we see really positive trends in commercial aftermarket.

Our next question comes from Gautam Khanna with Cowen. Please go ahead.

Congrats on a great career, Tom. I had a couple of questions. So people have asked a bit about the second half, and you mentioned the Q4 weighting. But just the midpoint implies somewhere around 19%, 20%, second half versus first half improvement in sales. And I wanted to get your sense now one month into the third quarter, of your confidence in that, maybe the high end versus the low end versus the midpoint. I know it's a wide range, but have you made any progress on the past dues to whittle the $100 million down? How much of it are you kind of embedding you catch up in the current fiscal year? And just how much maybe seasonality just naturally would give you a lift second half to first half because it seems like a big number percentage-wise, but if you put it out there, so I'm just curious?

Yes. No, it's there. Roughly, if you look at the bottom end of our range, that would imply no recovery or even worsening past due, okay? The high end of the range would imply we've made up a lot of the past due. Midpoint would be closer to where we are with a little bit of improvement, if that helps you. So...

No, that helps. And in the third quarter, have you seen a step-up in monthly run rate of output such that...

Yes. Yes, so we got - we just - as you know, just got one month under our belt. I would say it was tracking - we had a slight improvement in March and slight in April, which is why I highlighted earlier, we need a large fourth quarter to get into that midpoint of our range and above.

Okay. And you guys have called out - I think this quarter was $1.7 million, $1.8 million of nonrecurring expenses related to business development or something. And in Q1, it was another number, by memory, 2.8, something like that. Are these related to the same category of items? Like what is it? And yes, if you could just elaborate on what it is, why we're backing it out.

Yes. Let me try to clarify for you, Gautam. In Q1, we took two separate adjustments that we called out. One was $2.9 million related to business development costs and the other was the $5 million related to nonrecurring, nonoperational impact that we had. Just to clarify, this quarter, we reduced the $5 million charge by $1.7 million. So now it's a net of $3.3 million. So it was a favorable item in Q2 that we adjusted back out because we had the unfavorable item in Q1.

Okay. Got it. And maybe just on cash deployment, you have the $800 million buyback authorization, minus what you've done. How quickly do you expect to execute that? Are you going to - with the cash flow guide coming down a bit, are you going to toggle down the pace of the buyback? Or does it matter? Does that impact it at all in terms of paying...

Yes. We believe in our long-range plan. And we also had cash on the balance sheet in a fairly unlevered balance sheet. And the Board of Directors, Mark and I, all agreed to return capital to shareholders. And I think we're tracking very well to that $800 million. We said we're going to return. And we intend to return that over the 2-year time period. But we don't have a rate at which we're going to finish that out, but we do intend to return all that in the time frame we have allotted.

Our next question comes from Noah Poponak with Goldman Sachs. Please state your question.

Tom, congratulations on your retirement. What did you take out of the full year revenue guidance range? What makes up the $50 million to $100 million that came out?

Well, as I highlighted, a chunk of it came out of deliveries to China. We have a FX headwind that's impacting the top line with the strong dollar. We also reduced a little bit in all businesses based on deliveries. That's the past due that we've talked about due to supply chain disruptions and COVID-related disruptions. So it's a little bit across the board, but those are the big ones.

The $30 million of supply chain, COVID logistics that you cited for the quarter that was $70 million last quarter, it sounds like that $30 million was sort of - was a surprise and comes out or I guess maybe that there was some assumption for that and the $30 million was larger than the assumption. Do you have to incrementally assume something less favorable for 3Q and 4Q than you had in the prior guidance for that as well?

Well, it's just kind of what I highlighted a little bit earlier, the $30 million was really primarily additional supply chain issues. In particular, we had some real impacts around our electronics.

Yes. I guess where I'm going with that, Tom, is if there was $30 million in a quarter and now there's - it sounds like you're thinking and others are thinking that supply chain issues that seem like they might resolve themselves sooner than later, are now looking like they're going to last through the end of the calendar year. And so if it's a $30 million a quarter run rate, maybe it's not $30 million because maybe it gets a little better in the back half and maybe you had some assumption in the old guidance. But if it was 30 times three quarters and then China shut down on you and then some of the deliveries are worse, and then there's FX, it just sounds like that adds up to more than $50 million to $100 million is where I'm going.

Well, a little bit - I was just saying this a little bit earlier, if you look at the range we gave, we do and believe we will make progress on recovering some of that $100 million in the second half. But if you take the goalposts on the range, at the bottom end is we're not going to get any better and maybe even a little worse, top of the range is yet we really recover really well. I do believe we will recover. We're seeing progress in all areas except for electronics at this time, and we're working really hard on the electronics. We also anticipate a sizable improvement in labor efficiency from all the direct labor we've hired. And that will help efficiency and production rates go through. So I do believe we'll make progress on that $100 million. Our previous belief was we were going to be sooner on that recovery and obviously, we're not. And so that's why we decided the right thing to do was call down the year. But we are making progress, and I do believe second half will improve.

Will you be losing sales to new supply chain challenges in the third and fourth quarter that you didn't have in the guidance previously while making up the old ones?

We anticipate really no lost sales. And that's really - you got to go back, all of our - I'm going to say, 98% of all of our business is sole sourced, so...

No, I don't mean permanently lost sales. I just meant like to the extent that supply chain challenges are lasting longer than expected, it would seem like fiscal 3Q and 4Q would have an incremental hit to them compared to the old guidance from supply chain even if you're making up some of the old stuff.

Yes. There is some that we have factored in, and I'll give you an example. And this is across the industry, not just Woodward. So a lot of times, we have aftermarket, like, say, in our Industrial business, a refinery or a power plant goes down for maintenance. They want to know they have everything ready for that outage. And right now, we see a few of them delaying the outage because they can't get all the hardware. So that's been factored into our outlook. Now that is not a lost sale, it's delayed, I mean, because they will do that outage and that maintenance, but they are pushing them out because not only Woodward, but other suppliers are late. And so that is maybe what you're asking about. Noah, that type of thing is happening. But once again, it's a pushout, not a lost - not a permanent lost sale.

Okay. Yes. No, that makes sense. I'm just trying to square up the new virtual report but that's helpful. And then if I go to the Aerospace margin guidance, the 18% for the year, I think it implies basically just a clean spot on 40% incremental 3Q and 4Q, maybe won't be exactly that, but back half in aggregate. If the pricing increases take a little while to flow through as you alluded to, and you still have that new labor inflation right away, is 40% achievable with that going on? I want to make sure I have that right.

Yes, we believe that's achievable. And really, the one lever in addition to our normal incremental operating flow-through that we see is really capturing that labor efficiency as we move forward from all of the direct labor that we have hired that impacted us here in Q2. So as we become more efficient, the build rates go up, members become more productive on the line, those incrementals will flow right through on that increased volume.

Okay. Got it. And just one last one. Why is the guidance for free cash flow revised so much more than EBITDA?

Yes. So it all comes down to - and Tom mentioned it a little bit, and I mentioned a little bit in my prepared remarks. It all comes down to working capital. As you see, we have a large second half. And as Tom mentioned, a ramp in second half and Q4 will be larger than Q3. What we're anticipating in that is our receivables balance will be larger than anticipated previously. Now the great thing about that is, again, it's not lost cash. It's just delayed cash into fiscal '23. And - the other is as inventory balances are a little higher today given the COVID disruptions and we do plan on working those down, but they may be higher than what we had originally anticipated given where we're at today. So between those - really those two factors on the working capital, AR and inventory, that's why the cash flow impact is significant as it is. But again, it's just a timing thing. It's just a delay to cash into fiscal '23.

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

Well, thanks for joining today, and I appreciate working with all of you. I've always enjoyed our interactions, and I appreciate that you know our markets and have learned our business. And I've always found it enjoyable to interact with you guys and keep doing a good job and Mark and Chip will, I think, carry on with you. We do believe in trying to give you good information be transparent. And we've got a great company here. It's going to come back from these disruptions. We'll be back on our long-range plan in no time. So I appreciate that. And I guess as a parting comment, you guys kind of took it easy on me today, so I appreciate that as my last call with all of you. So maybe I'll run into you in the future when I'm out in New York or and the like. So thanks a lot, and talk to you soon. Bye.

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 6577704. A rebroadcast will also be available at the company's website, www.woodward.com. We thank you for your participation in today's conference call and ask that you please disconnect your line.