Woodward, Inc. (WWD) Q2 2026 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Woodward, Inc. Second Quarter Fiscal Year 2026 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 Chip Blankenship, Chairman and Chief Executive Officer; Bill Lacy, Chief Financial Officer; and Dan Provaznik, Director of Investor Relations. I would now like to turn the call over to Dan Provaznik.

Thank you, operator. We'd like to welcome all of you to Woodward's Second Quarter Fiscal Year 2026 Earnings Call. In today's call, Chip will comment on our strategies and related markets, Bill will then discuss our financial results as outlined in our earnings release. At the end of 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 included some presentation materials to go along with today's call that are also accessible on our website, and a webcast of this call will be available on our website for 1 year. All references to years in this call are references to the company's fiscal year, unless otherwise stated. I would like to highlight our cautionary statement as shown on Slide 2 of the presentation materials. As always, elements of this presentation are forward looking, including our guidance and are based on our current outlook and assumptions for the global economy and our businesses more specifically. These elements can and do frequently change. Our forward-looking statements are subject to a number of risks and uncertainties surrounding those elements, including the risks we identify in our filings with the SEC. These statements are made as of today, and we do not intend to update them except as required by law. In addition, we are 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. We believe this additional financial information will help in understanding our results. Now I'll turn the call over to Chip.

Thank you, Dan, and good afternoon to all who are joining our Second Quarter 2026 Earnings Call. I'm pleased to report that Woodward delivered an exceptionally strong second quarter. Our team continues to execute with focus and discipline to meet ongoing robust demand across both our Aerospace and Industrial segments. Before we get into the results, I want to take a moment to acknowledge the complex global environment we're operating in. I'd like to thank our Woodward security professionals, our leaders and members in the region for their vigilance in keeping our team members operating in the Middle East, safe. I also greatly appreciate our customers in the region for their collaboration on safety and coordination as we adjust projects that are underway there. While the safety of our team is our first priority, we're also closely monitoring broader geopolitical developments and how those might impact defense spending or airline traffic. If those impacts do occur, we expect them to be felt in fiscal 2027. Let me turn to a few financial highlights for the quarter. The second quarter marked a significant milestone for Woodward as we surpassed $1 billion in quarterly sales for the first time in our history. Sales increased 23% year-over-year reaching all-time highs in both Aerospace and Industrial. We also delivered margin expansion, including record quarterly adjusted earnings per share, up 34% from the prior year. These results reflect the strength of our end markets, the benefits of our strategic focus and the steady progress we're making in our operations. Our members' tremendous efforts and dedication to continuous improvement, not only enabled us to deliver another quarter of outperformance, but also positioned us well for the second half of the year. While we are monitoring uncertainties in the geopolitical environment, we're raising our full year sales and earnings guidance based on our second quarter results and confidence in the remainder of 2026. Turning to our markets. Here's a breakdown of what's driving the robust demand in Aerospace and Industrial and what it means to Woodward. In Aerospace, commercial aircraft build rate increases are coupled with overlapping maintenance cycles of legacy and current generation fleets. In Industrial, we see power generation demand expressed in both power gen and oil and gas end markets. These market drivers create durable growth opportunities for Woodward. Our challenge in this environment is to continue to expand our capacity and that of our supply chain in ways that are well managed and resilient. We are doing the right work to achieve these outcomes. At times, however, we've seen demand outstrip our activities like dual sourcing projects or our additional test and procurement, installation and calibration, which are 2 real examples of what constrained output for us last quarter. In Aerospace, we saw expected growth in both commercial and defense OEM along with continued strength in commercial services. Legacy services activity remains solid, and we're seeing steady increases in volume for our control systems on LEAP and GTF engines. Shop inputs remained steady and we haven't seen any decreases as a result of airlines recently announced capacity and utilization reductions. In Industrial, momentum continued across all our major markets, including oil and gas, transportation and power generation. Our ability to deliver on this robust demand reflects strong execution across the company. Moreover, our team is managing order growth, while simultaneously undertaking numerous critical projects to optimize our portfolio, strengthen our competitiveness and position Woodward for long-term growth. We remain focused on our value drivers: growth; operational excellence; and innovation. Our profitable growth pillar contains both organic and inorganic lines of effort along with selective divestitures and investments in capability, efficiency and capacity. These projects are changing the game in how we operate. They're also allowing us to focus on areas with the greatest potential to strengthen value creation. Our recent announcements reflect purposeful portfolio management decisions that our team has been working to activate over the last 1 to 2 years. In March, we closed the acquisition of Valve Research & Manufacturing, adding the premier designer and manufacturer of solenoids to the Woodward portfolio of control systems. These are critical enabling technologies for current and future aircraft with next-generation single-aisle platforms clearly in our sites. We also see opportunities related to Industrial Gas Turbine control systems, integration is progressing well as we welcome our new team members in Southeastern Florida. We also announced the sale of our Niles-based pilot controls product line to Ontic, a mutually beneficial transaction that will enable us to refocus resources. In addition, we communicated the relocation of servo valve production lines from our facility in Santa Clarita to Rockford. Rockford is our world-class servo technology design and manufacturing center where we intend to achieve the necessary quality and delivery improvements required for our customers and shareholders. In Industrial, our actions to wind down the China On-Highway product line remain on track and last-time buy volumes are reflected in our second quarter results. All of these actions streamline and strengthen our portfolio and sharpen our focus on our most attractive near- and long-term growth opportunities. These decisions allow us to serve customers better on our current book of business. And by trimming product lines that don't have a path for us to be best-in-class and by moving work to where we can be more effective and efficient, we can focus on partnering with our customers to tackle their biggest challenges with their next generation of products. Our 2 biggest construction projects, Spartanburg and Glatten are both on track. Our new facility in Spartanburg, which will be the location for Airbus A350 spoiler actuation systems is on schedule. Walls are erected and floors are being poured as we speak. We are on target to be operational in 2027 and begin deliveries the following year. Our Glatten expansion to deliver more diesel fuel injectors for data center backup power is almost complete. We have moved over 100 machines within the new hall and legacy areas to perfect flow. Our teams have demonstrated the major achievement of small batch flow and customers will see substantial capacity increases with reduced lead times. This will translate into cost productivity and better inventory turns. While I've been vocal with many analysts and investors that Woodward has the facilities and capacity to support the ongoing power generation demand and data center accelerator to that demand growth, multiple customers have recently shared potential increases to their forecasts. We are working with our customers to evaluate the opportunities and capacity options. Shifting to growth in Aero MRO, the volume on LEAP and GTF is growing quickly. We continue to increase capacity at our Rockford and Prestwick sites with Kaizen activities focused on flow and turn time. We have added test and capacity at Rockford, and we are progressing with the expansion plans for Prestwick. As we've indicated in prior earnings calls, we have a strategy to perform repair and overhaul service in-house as well as through license providers that will deliver to OEM standards. This approach allows us to optimize our capital and internal resources and support our airline customers in the way they prefer to contract for maintenance and repair. It is a well-respected open maintenance model that we have refined to suit Woodward's strategy on LEAP controls components. Last week, we announced new partnerships at MRO Americas, including new licensed repair service facility agreements with Lufthansa Technik and Air France KLM as well as a new distribution agreement with AAR. We are thrilled to be partnering with industry leaders in MRO and material support. These partnerships expand our global service network, increase capacity and give airlines flexibility in how they contract for service. Moving to our operational excellence pillar. Investments in automation continue as we execute projects as simple as increasing the closed door machining time as a total percent of the job and as complex as full assembly and test automation with vision systems and integrated inspection. We're also introducing repeat automation projects to additional sites, leveraging the automation lab in our Rock Cut facility. This lab was recently recognized by the Manufacturing Leadership Council as leading the way in manufacturing excellence. I see firsthand the results of continuous improvement nearly every day. I was recently visiting the industrial SOGAV value stream in our Fort Collins site and was impressed with an automated cell that allows one operator to manage 3 machines and turn a production bottleneck and staffing challenge into a high-speed machining cell that can outrun our current demand forecast. We need both capacity and productivity to achieve our goals in the long term. To us, it's equally exciting to create value for customers and for shareholders. As indicated by the list of projects I described above, our team is managing a high level of activity across the company, while at the same time, improving delivery to our customers and our financial results. We continue to invest in our people and our talent pipeline to make sure we have the engineering, manufacturing, business support and leadership needed to enable our growth trajectory. For example, we recently launched a rotational program to develop the next generation of Woodward leaders with the first cohort starting in June, yet another step to build a high-performing organization designed for the future. Turning to innovation. Innovation has always been and will continue to be a major competitive differentiator for Woodward. As I said last quarter, we're turning from pure technology development to more technology demonstration activities with our Aerospace customers. We have entered into collaborative agreements with many of our current customers to work together on trade studies and demonstration programs. This is an exciting time to be an innovator with a track record of industrialization. We will speak more about this trend at Investor Day late this calendar year, but you will see Aerospace R&D expenses beginning to tick up this year and more so in the years that follow as future aircraft timelines firm up. In Industrial, one focus is on a new actuation platform to provide precise fuel and error control on reciprocating engines that will deliver more customer value and is designed for a more efficient automated production system. It is more compact in size and produces a broader torque range than prior models, which allows us to simplify the product portfolio and use this platform in many applications. The product will enter service in 2027. Our priorities remain clear as we head into the second half of the year, meet OEM demand growth, deliver world-class service across our installed base, including legacy Aerospace, LEAP, GTF and Industrial Gas Turbine Systems and demonstrate customer value on key technologies to position Woodward for increased content on next-generation single-aisle aircraft. We are entering the second half of the year from a position of strength, and we'll continue to invest with discipline and focus to deliver long-term shareholder value. With that, I'll turn it over to Bill to take you through the financials in more detail. Over to you, Bill.

Thank you, Chip, and good evening, everyone. As Chip mentioned, Q2 was a strong quarter. Quarterly net sales exceeded $1 billion for the first time in Woodward's history coming in at $1.1 billion in the second quarter of 2026, an increase of 23%. The significant growth reflects strong demand and increased output in both Aerospace and Industrial. We achieved earnings per share in the second quarter of 2026 of $2.19 compared to $1.78. Adjusted earnings per share were $2.27 compared to $1.69. We generated $38 million of free cash flow in the second quarter. At the segment level, Aerospace segment sales for the second quarter of 2026, were $703 million, an increase of 25%. The strong growth was primarily driven by Commercial Aerospace. Commercial Services increased 36%, reflecting higher repair volume to support the continued high utilization of legacy aircraft as well as increased LEAP and GTF activity. In addition, spare LRU sales growth was strong in the quarter, with volume consistent with the previous 2 quarters. Commercial OEM sales were up 30% and we believe destocking is largely behind us as their output is now more aligned with current airframers build rate. Defense OEM sales grew 9%, primarily due to increased JDAM pricing that took effect in the fourth quarter of 2025, and Defense Services grew 8%. Second quarter Aerospace segment earnings were $158 million or 22.5% of segment sales compared to $125 million or 22.2% of segment sales. While the strength in Commercial Services, higher commercial OEM volumes and solid price realization drove meaningful margin expansion, this was largely offset by planned strategic investments to support future growth and inflationary pressures. This reduced the Aerospace flow-through in the quarter, resulting in a net margin increase of 30 basis points. These strategic investments included enhancements to our manufacturing capabilities to deliver the content on current platforms, incremental R&D tied to early-stage efforts to compete for the next single-aisle aircraft platform and an enterprise-wide ERP upgrade. While these initiatives are impacting margins, they are critical to positioning the company for sustained long-term growth, and we expect these investments to continue. The flow-through in the full year 2026 Aerospace guide is expected to be at a targeted rate of approximately 30% to 35%. Turning to Industrial. Industrial segment sales for the second quarter were $387 million, an increase of 20%. Core Industrial sales, which exclude the impact of China On-Highway, increased 19% in the quarter, driven by higher volume, price and favorable foreign currency impacts. Marine Transportation sales were strong, increasing 34%, reflecting higher shipyard output and services activity. Oil and gas sales grew 18%, driven by higher volume, primarily related to greater midstream and downstream gas investment. Power Generation sales increased 7%. Excluding the impact of the prior year combustion business divestiture, Power Generation sales grew in the high teens on a percentage basis. This was driven by increasing data center demand for both base and backup power generation. Outside of our core Industrial business, China On-Highway sales were $29 million in the quarter. We expect approximately $30 million of sales in the third quarter and minimal sales in the fourth quarter. Industrial segment earnings for the second quarter of 2026 were $66 million or 17% of segment sales compared to $46 million or 14.3% of segment sales. Within our core Industrial business, margins were approximately flat at 14.7% of Core industrial sales, as strong price realization and higher sales volume were partially offset by inflation. In addition, margins were negatively impacted in the quarter due to a reserve for a product performance claim. Excluding the reserve, Core Industrial margins would have been in line with Q1. The China On-Highway business added an additional 230 basis points of margin growth in the quarter. Nonsegment expenses were $45 million for the second quarter of 2026 compared to $27 million. Adjusted nonsegment expenses in the second quarter of 2026 were $38 million compared to $34 million. At the consolidated Woodward level, net cash provided by operating activities for the first half of 2026 was $205 million compared to $112 million, largely driven by higher earnings. Capital expenditures totaled $97 million for the first half of 2026. We continue to expect a meaningful increase in capital expenditures over the next 2 quarters consistent with our guidance for the full year. As Chip mentioned, construction of the Spartanburg facility to support future A350 production is progressing as planned. We remain on track to finish the building over the next few quarters and are beginning to purchase production equipment with the site expected to become operational in 2027. In addition, we continue to make strategic investments to support growth related to current platforms, including automation, preparing for increased LEAP and GTF service activity, our ERP upgrade and product line moves. We generated $109 million of free cash flow in the first half of 2026 compared to $60 million, driven primarily by higher earnings, partially offset by higher capital expenditures. As of March 31, 2026, debt leverage was 1.4x EBITDA. We continue to allocate capital according to our priorities, supporting organic growth, selectively pursuing strategic M&A opportunities and returning capital to shareholders through dividends and share repurchases. Regarding strategic M&A, we recently completed the acquisition of Valve Research & Manufacturing. Consistent with our strategy of pursuing targeted, high return opportunities that enhance our capabilities and improve our position to compete for the next single-aisle aircraft. In addition, in line with our portfolio optimization efforts, we recently announced the divestiture of our pilot controls product line, which we expect to close by the end of the year. We are building a stronger, more focused Woodward as we invest in high-growth opportunities and expand in the right areas to position Woodward to create additional value for shareholders. In the first half of 2026, we returned over $355 million to stockholders through share repurchases and $36 million in dividends. Our strong balance sheet provides flexibility to move decisively as compelling opportunities emerge. Lastly, our fiscal 2026 guidance still assumes the return of between $650 million and $700 million through dividends and share repurchases. Turning to our 2026 guidance. Based on our strong second quarter performance and confidence in the second half outlook, we are raising our 2026 sales and earnings guidance. For 2026, we now expect the following: Aerospace sales growth between 21% and 24% with margins increasing to be between 23% and 23.5%; Industrial sales growth between 18% and 20%, with margins increasing to be between 18% and 18.5%. We now expect total Woodward sales growth between 20% and 23%, and adjusted EPS between $9.15 and $9.45. Free cash flow is still expected to be between $300 million and $350 million, and capital expenditures are still expected to be approximately $290 million. We expect to continue to maintain higher levels of inventory than previously anticipated as we prioritize to meet customer demand, while we strive for better alignment for the end-to-end supply chain. We have a number of inventory initiatives underway, which should drive improved free cash flow generation in 2027. We now expect our average diluted shares outstanding to be approximately 61.5 million Adjusted effective tax rate guidance is unchanged. This concludes our prepared remarks on the business and results for the second quarter of fiscal year 2026. Operator, we are now ready to open the call to questions.

[Operator Instructions] And our first question comes from the line of Scott Mikus with Melius Research.

On a sequential basis, your commercial aftermarket sales were up 12%. In the opening remarks, I think it was mentioned that the LRU volumes were roughly consistent with the prior 2 quarters. Since the quarter has ended, have you seen a drop-off in orders for spare LRUs. And are you concerned that if there is a broader slowdown in the aftermarket the amount of LRUs in the field could result in destocking pressures in the back half of this year or early in '27?

Yes, Scott. Let me jump on the front part of that. And then Chip, maybe the second part. But as we head into third quarter, and as we've mentioned, these orders for these spare LRUs are rather short cycle, so we don't have a ton of visibility. But we're comfortable that sequentially, Q3 spare LRUs are in line with what we've seen in the first 2 quarters. And again, from a financial forecasting standpoint, tough to say what Q4 looks like currently. But Chip, I don't know if you want to...

Yes, we've certainly seen some airline signaling that they're removing a little bit of capacity. They're parking some planes. But none of the parking activity exceeds any of the forecasts that were already in play. And we haven't seen any drop-off in inputs to our shop for -- from LRUs for repair. And we haven't seen any slowdown in the order rate for spare LRUs. And so there's always assumptions in the forecast, but we haven't seen any indications in our direct connections with customers to indicate that we're going to see a slowdown inside our fiscal year. That being said though, we are obviously monitoring the situation at the higher level, geopolitical and macroeconomic. And as far as what that means for FY '27, we'll all have to ride a little further along to see where that goes.

Okay. And then a lot of energy infrastructure in the Middle East has been damaged in the ongoing conflict and it will need to be rebuilt. Just curious how you're thinking about that opportunity for your Industrial business are you receiving RFPs from your customers to support that reconstruction, fully understanding that, that probably won't hit the P&L for next year, though?

I think we're a little bit further down in the supply chain to be seeing initial outreach on that for anything except service activity. So we have some ongoing projects, and a number of them are back up and running as far as service for our customers, be it on the valve type equipment or on the control -- electronic control systems for gas turbines and power plants. So that activity is ongoing. Some of the things that need to be rebuilt as the customers and operators reach out to EPC type companies that will flow down to us and we haven't seen anything along those lines yet. But there'll probably be some opportunity.

And our next question comes from the line of Sheila Kahyaoglu with Jefferies.

We could focus on margins for both Aerospace and Industrial. So first on Aerospace, just first half margins just under 23% with fiscal Q2 at 22.5%, yet you raised the full year to 23.5% at the high end. Can you just talk about what drives that second half margin expansion? What are the puts and takes?

Yes, I'll just let Bill start there, and I'll jump in at the end.

Yes. So Sheila, we do continue to see good growth in -- on the services side of the business. And obviously, that helps our margin rates, while we continue to see the volume growth, which creates leverage. And then as we've been talking about Sheila, we've been investing and working hard on our lean activity and that work is paying off as we see the shipments increase. So those are some of the key things we continue to have good pricing in Aero and are managing our inflation well. So our -- so we're seeing that positive flow through to our bottom line as well.

Okay. And then maybe on Industrial core margins, they stepped down almost 300 bps.

Yes. Sorry, Sheila, good you asked that. Sorry, in Q2, we did have a reserve that we put up and that impacted Q2 margins for Core Industrial. If you back that out, the margin rates are on the bottom line with what we saw in Q1, and we expect the second half to be more aligned to that -- what we saw in Q1. And operationally, what we saw in Q2, we expect that to continue in the second half.

Yes. Maybe just -- sorry, can you expand on what that product reserve was? What drove that? How big was it?

Yes. So it's simply a matter of a long-standing product development program with the results that we see a little bit differently than our customer sees it. And that's about all we'll able to share at this time, it's a matter that's being undertaken to the legal process. So we're not going to comment much more on it.

And our next question comes from the line of Noah Poponak with Goldman Sachs.

Chip, everyone is trying to figure out what's going to happen with Aerospace aftermarket. I guess as you described not really seeing much yet. I'd be curious to just hear given your experience in the market over a long time, like why do you think you haven't seen anything yet? Why do you think the airlines are not responding that much yet? And when you talk about the possibility of there eventually being a response and seeing that in your fiscal '27? If it were to happen, what would make it happen? What's the threshold? Is it a higher fuel price? Is it the duration of fuel price, just what are your customers telling you? And then is there any way to frame or think about Woodward relative to the market because you have so much more content on newer products versus older product, if capacity is trimmed or things are retired out of the back end of the fleet, is it safe to assume you see much less of that than the average player in the space?

Okay, Noah, I may ask you for a repeat of the second half of the questioning, but I'll jump on the first half. I think you used the word duration, and I think that's the main question that is unanswered at this time in terms of what happens to fuel prices. My experience in situations like this is the reason things haven't happened very quickly from a negative standpoint is that there's still a strong traffic demand out there. And then the airlines that have decided to try to pass along price to the airline customer that has not resulted in destruction of demand. And so I think everyone is kind of a little bit walking on egg shells, trying to see how much of this cost impact that airlines are seeing from oil prices can be passed on from passengers about reducing load factors on flights. They've taken some very smart decisions to take out some lower load factor mid-day, mid-week city payers, I think, and put some higher fuel-burning aircraft to the site. So all those are sort of prudent actions to take a look and see what's going to happen next from a traffic standpoint. Demand is still strong. So I think people are continuing as they were with their maintenance programs. And if the duration and the price of fuel continues to climb, then load factor breakeven points between city payers is going to cause more planes to be parked and maybe there'll be some destruction of demand if prices go up too much. So none of those if statements that I said have happened yet. So I think it's business as usual, a little bit on the maintenance side. Some of our peers are -- may seem like they're being a little more cautious with their quarterly results announcements. But if I remind everybody, we're halfway through our year. So we've got a little bit more in the rearview mirror already accomplished on the books. We've got a little less in front of us to ride on this duration question than our peers do. So hopefully, that sorts that out. Second question, I think you asked was about what's specific for Woodward having higher content on the current generation of narrow-body, the higher technology fleet with better fuel consumption performance. I think from our standpoint, legacy narrow-body repair business continues to grow much to my -- a little bit of a surprise, and we didn't forecast it growing quite as much year-over-year or quarter-to-quarter as it did in Q2. So things are still looking good on legacy utilization front. But if we come to an oil shock that's even more and longer duration than we see right now. If the newer technology fleet gets utilized much more than the older technology fleet for Woodward, it happens to be good math. It's not good for the whole industry. We don't wish that on the industry. But if that does happen, we have a little bit of a hedge there because we have a faster growing, higher content position on that fleet.

Okay. That is super helpful. I appreciate all that. And then just a follow-up on the Aerospace margin. Would it be possible to quantify the incremental investments you made in the quarter, just so we can all sort of keep tracking the underlying trend you've been experiencing there? And then on the pricing front, you guys have been providing kind of total company and then directional within the aftermarket pricing any update you could provide on what happened there in the quarter?

On the first piece, Noah, I -- what I'll say is we're focused on making sure that we've got the systems, the processes, in place for us to continue to execute on our key imperatives. We are going to be diligent and thoughtful about how we increase that investment, not getting too ahead of the volume growth, but not being so far back that we can't execute on it. And so as you can see, there's still margin expansion that we're looking for in the results based off of our guide. And so I think we're being responsible and reasonable with how we are increasing the spend as it relates to those strategic projects.

Yes. And I'll just jump in and say that Bill had alluded to this in some of his remarks, but we have increased our R&D spend a little bit in Aerospace. Much of that is aimed at the preparation, the technology demonstration projects. We're working with our customers. We've invested in manufacturing engineering to accelerate our automation journey, which also feeds how we will industrialize for the next single-aisle aircraft components that we win. And as well, we've been building that plant in South Carolina and we are starting to staff up there some of our very key positions like plant leader and value stream leaders and some advanced manufacturing engineers. And so some of these our longer-term investments, some of the automation investments will provide returns sooner. But some of the staffing up that we're doing and the R&D expenses are really aimed towards the next generation.

And then Noah, I think you had a question on price, if that's right. And the price in the quarter was around 6.5%, 7% and that's roughly what we projected to be for the total year. Aero being a little bit stronger on the price side than Industrial.

And our next question comes from the line of Gavin Parsons with UBS.

What drove the Aero revenue guidance raise kind of between the subsegments? And then within aftermarket, how much of that is kind of the spares provisioning drop in versus repair and overhaul work?

Without getting quantitative about it, I'd say that the commercial services is really the largest piece of the increased revenue gain. We had forecast the OEM to be growing substantially and maybe hedge it back a little bit in terms of how we were thinking about it based on what the aircraft and engine OEMs would actually come through with orders for and sort of meter us to. But it's been a little bit more on the demand side from the OEM. So it's driven a little bit of the gain and the forecast guide, but Commercial Services kind of looking in the rearview mirror and thinking that, that will sustain at least through 3Q, as Bill said, with the higher LRU orders. But the repair is strong across the board in commercial services, wide-body, legacy narrow-body, regional and the LEAP, GTF, all contributing to revenue and earnings growth.

And Gavin, just to expand on that again. Obviously, the raise and guide was partly recognized in the strong Q2 performance, but also second half performance. Commercial OEM, defense OEM on the Industrial side, most of that OEM, and we see, especially in the fourth quarter, OEM being growing nicely, and that's a big part of the raise for the second half. And obviously, that will -- that has a different kind of flow-through pattern than the services that we saw in the second quarter and in the first quarter.

Okay. That's very helpful. And then, Chip, you pointed out that airlines are maybe sidelining some of the least fuel-efficient aircraft. I think over the long run, you guys have talked about flight hours as being the key metric driving your aftermarket growth. But if it's those older, less fuel-efficient aircraft being sidelined, is the risk going forward more about accelerated permanent retirements, delayed shop visits or maybe cut shop visit scope?

Just to clarify, are you talking about for the legacy fleet or in general?

In general, is the risk more about shop visits or retirements and less about flight hours?

Yes. I think for the legacy retirement -- for the legacy fleet, certainly, the risk is about retirement and part out and not getting another shop visit on our LRU, whether it's a V2500 fuel control or CFM56-5 HMU. And so that risk though, is like the end-of-life risk for the oldest part of that fleet. They still pick a number of 40% of airplanes with engines and LRUs that only seen one shop visit and are quite capable assets. The airlines are going to continue to fly. So flight hours is still going to correlate with how that equipment comes off and comes in for shop visits with us. And -- but the sort of end of life for the oldest A320s from our -- CEOs -- from our standpoint, that's going to happen based on a combination of traffic demand, price of fuel and OEM delivery rates, and we'll monitor that closely.

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

Great quarter. Yes. I just want to circle back to Sheila's question on Industrial margin. I just want to think about the right way to think about it going forward. If we exclude the provision in the second quarter, it sounds like you're maybe a tad over 17% on Core Industrial margin in the first half. And with the new guide, you get a little bit of a boost in the third quarter from China On-Highway, but then nothing in the fourth quarter, but it seems like you'd still be exiting around 18% or so in the fourth quarter. So it just seems like a lot of nice momentum in core industrial margin year-over-year. And so is the right way to think about it, the 18%, 18.5% is a reasonable range to think about for 2027 or maybe 17.5% in the low end? Or is there any logic wrong there?

Yes. We're -- just I'm real happy about 2026, Pete, and where that is. And I think how you laid it out is right. We continue to work hard on all our margin and productivity margin expansion and operational excellence initiatives. And we'll be talking to you real soon about how that all comes to play. But I think if Randy was here, he says he's not -- he would say he's not planning on giving up any ground, but we'll see how it all comes out in the mix as we start talking about '27.

Okay. Fair enough. Just one follow-up. On the pilot controls product line sale, is it fair to conclude that this product line has less aftermarket than the engine portion of aerospace. And so I'm just wondering if the divestiture is sort of margin accretive for you in Aerospace? And how much revenue is involved in that product line?

Well, I don't think we'll share the revenue specifics there, but it's not super significant. It is accretive to carve that out for us. That's one of the criteria we would use to examine a divestiture opportunity. A while back in our strategic review process, we just identified this as an area where we would have to put a lot more resources into this to become a leader in the industry in this area. Where we are a leader is in some of the enabling technology components and subsystems that go into pilot controls like throttle quadrants. So some of the precise motor controls and motors themselves as well as sensors and the LVDTs and hall effect sensors and things like that, things that we can bring to the party, and we will remain a supplier of those components to the company that we sold the main business line too. So we'll retrench into the places where we're the most competitive and have the most value add for customers and pass that along. Now it does have a good amount of service business to it, which made it kind of an attractive product line to sell for the buyer. So -- but still, from our standpoint, it was -- it's accretive to let it go.

Okay. So Niles will remain open. There are more production there than the pilot controls, that's right?

Yes. This was a relatively small value stream in the Niles facility.

And our next question comes from the line of David Strauss with Wells Fargo.

Chip, I think if I caught it correctly in your prepared remarks, you talked about additional step up in interest from your IGT customers and the potential that you might be looking at some sort of capacity expansion to be able to handle that interest. Did I get that right? And maybe if you could expand on that?

Yes, not just our IGT customers. So gas turbine, reciprocating engines, diesel-powered, natural gas-powered backup prime power applications. So it's like across the board, multiple OEMs in each of those categories over the last really a month or so have come to us and said, we want some capacity studies for these kinds of forecast between now and 2030 plus. And so we've been sort of digesting those requests. And it's not one customer. It's not one technology, but it's largely driven by data center caused power generation demand. And so we're looking to respond to these customers. But the reason I wanted to lay that out and what may seem like an early way in this earnings call is that as I've been meeting with investors and analysts, I've really kind of been firm that based on everything I see from our customers, we have the footprint, and we have the ability through Kaizen and other continuous improvement, elimination of waste, lead time reductions, things like that, we could make our way to solve for the capacity that's needed. But this new later breaking information says that maybe we need to consider capacity increases.

Okay. I guess we'll check back in on that later, where you come out. If I missed it, I apologize. Did you talk about where LEAP, GTF aftermarket revenue volumes, however you quantify, are relative to legacy at this point and where -- if the crossover point has changed?

Yes. So I didn't mention it in the prepared remarks, but thanks for the question because it's one that we talk about quite a bit. What's really interesting to me and our team is that as we grow LEAP in a substantial way, the legacy narrow-body fleet continues to provide inputs to our shop, and we're like, okay, it's kind of growing at a good clip still for the legacy fuel control units, especially. I'm not changing the forecast right now. We said sort of end of '26, sometime in '27. We still think that's a reasonable assumption. The things that could change -- pull that in, the fuel price shock that we talked about could reduce the rate of input for the legacy. And that would be like a not so interesting way to have the crossover be pulled in. We like it to go further to the right. The other thing I would say, just to give a little bit more color to what we're talking about is that right now, this quarter and even last quarter, the total amount of service revenue is about the same for LEAP, GTF compared to the legacy narrow-body, if you include the spare LRU items. So from a repair standpoint is the crossover that we keep talking about looking for is a few quarters out in the future. But I just wanted to share that we're already kind of in the very similar numbers from LEAP, GTF compared to V2500 and CFM-5, if you include all the different kinds of service products that we offer.

That's great. You predicted my next question or follow-up question.

And our next question comes from the line of Ken Herbert with RBC Capital Markets.

I just wanted to maybe follow up on the free cash flow guide. It didn't change with the sales and EBIT increases. Is that just reflecting as you continue to talk about higher working capital spend or working capital as a percent of sales? Is that the right way to think about it? Or is there anything else impacting on the free cash flow side?

No, Ken, I think that is the right way to think about it. Simply stated.

Okay. Okay. That's helpful. And I wanted to follow up on the announcements with LHT and Air France KLM. How quickly will those scale as sort of third-party MRO providers? And should we expect maybe a movement of -- a block movement of spare parts or inventory at some point in the next few quarters as they ramp or maybe as part of these agreements?

Yes. So the rate-limiting step for any of our licensed service providers is going to be getting test stands in procured, installed and calibrated. So that's 9 to 12-plus months away depending on where each of the folks are in the procurement cycle of that. So it's definitely not a 2026 kind of thing, and we'll give some color to how we expect the standing up of these partner providers to affect our Service business is along with our Investor Day information late in the calendar year.

And our next question comes from the line of Christopher Glynn with Oppenheimer.

So I was curious if you've -- curious, have you guys evolved any like different angles on visibility to the China LRU markets?

As far as new angles, I would just like the easy answer is no on that. But what I would say is that we're starting to see just like more across the board as expected, based on airplane deliveries, customers ordering spare LRUs to provision for their fleet uninterrupted operations and the maintenance cycles that are coming. So I think we can kind of take the China moniker off the table for now, and they're ordering kind of like you'd expect them to order based on how many planes they have.

Okay. So maybe a little bit of a tempest in the teapot discussion for the past couple of quarters, sounds like. And then curious on the L'Orange model, don't recall like really discussing if they have much military in there. I suspect they do. I don't think your guided missile destroyer program was L'Orange, but rather your Power Gen business. But I just wanted to check in on that the military business pipeline overall for industrial and as it resides or doesn't within L'Orange?

Yes. So I would consider L'Orange to be 99-point something commercial as far as I know, I don't want to say 100% here, but it's just -- it's not something we think about or consider for what our diesel fuel system business contributes to. As far as the destroyer DDG class that are powered by gas turbines, both for propulsion as well as for onboard Power Gen, that's really the business that we participate in. It's the electronic control systems for controlling the power from the gas turbine as well as controlling the propulsion systems.

And our next question comes from the line of Louis Raffetto with Wolfe Research.

Maybe, Bill, just on the China On-Highway. I know you said $30 million of sales in 3Q. Should we expect to see similar levels of profitability that we saw in the last 2 quarters?

For Q3, that's correct. Obviously, there is going to be a restructuring charge that flows through. So operationally, Louis, correct, but I do want to make sure I highlight that there is going to be a restructuring cost that comes off. That will be separate as we go through the quarter.

Okay. Great. And then, Chip, maybe just to come back to what you just mentioned about the LRUs. So obviously, as we get to your fiscal fourth quarter, you're going to be coming up on a tough comp. But what I'm trying to understand, based on what you just said is are the LRU sales that you saw this quarter? Are they not China? And it's -- you're kind of saying don't think of this as a separate bucket anymore and everything is kind of one big bucket nowadays? Or is there still sort of a China bucket out there that we need to be mindful of?

I'm saying the former, which is there's really not a China bucket anymore. That was when we had our first step-up in LRU -- unforecasted LRU sales within a quarter, that was due to a little bit of a surprise order stream starting from China. That lasted a couple of quarters. And then as I kind of was alluding to, the rest of the orders inside the quarter are more spread out to European and U.S. and Latin America and in every other airline that's ordering aircraft and provisioning to support their fleet. So I would put the China bucket behind us for now and kind of how we see the rest of the year shaping up. We -- as Bill said, we have -- we largely have the LRU orders in hand for 3Q. We have good visibility to 3Q, and it is a good mix of customers. So less risk of being a nonrepeat kind of thing. But our visibility into 4Q is what we would normally see at this point, not fully clear in terms of who's going to order and how much it's going to be. But we have enough confidence in all the different levers of our OE and Service businesses in both segments to say we're confident in what we've put up for our guide.

And our final question comes from the line of Gautam Khanna with TD Cowen.

I was curious, just, could you quantify what the guidance revision was for just China OH relative to the prior outlook?

What the guidance revision was for...

We really didn't take that.

Yes. Yes, Gautam. Not much. I mean I think the guide, the upper end to the lower end considered what we're seeing in there for China OH. So I think at the beginning of the year, we said it was going to be around $60 million, and where we've ended up with what we've had and the last time buy, it will probably be somewhere around $90 million in total. So that was sort of within the range of our guide. And so we -- so anyway, that's how we handled it.

Okay. And in terms of profit variance, when you had the $60 million, what was the expected profit? And then if it's $90 million what's the new expected profit?

Yes. So we talked a bit about at certain levels, it starts to go beyond breakeven and then it flows through quickly through that point. We are at that point, and so that's what sort of generated. I think in the comments, we said it was worth about 230 basis points this quarter to the overall industrial earnings increase.

Okay. I was just curious what the revision is related to that. We can take it offline.

Yes, I would just emphasize, Gautam, that the China OH wasn't really driving the revision to guidance. It's more the success we've had in the first half with commercial Aero services and continued strong OE in both segments.

Yes. No, I got you. That's clear too. The -- to Pete's earlier question on industrial underlying margins kind of over time, how far along are you guys in that process of kind of looking at which SKUs to stock, which ones to retire kind of the operational turnaround within the Industrial business. How far along are you in that journey? And do you have any ballpark sense for where margins ultimately can get to in that segment?

Yes. So far, I've always answered that question saying we're in the early innings. But I feel, honestly, like we're in the middle innings in the industrial portfolio rationalization, turnaround, I use the word turnaround. I've not really use that, but I think it's an apt description. That team is just really pulled together and made some difficult decisions. You see the China On-Highway exit that we're doing, that was a difficult call. Some of the product lines we've exited were difficult calls around small engine and other things like that. But what we're doing now and what you can see now is that we are more -- introducing a more standard disciplined product management approach to the business. And so I talked about this actuator in my prepared remarks that is going to enter into service in 2027 that's now in the test phase, and we're industrializing that's going to replace a pretty complicated portfolio of actuation for reciprocating engines. So it's not like we looked at the portfolio and said, we don't want to be in that business anymore. We said there's a better way to serve customers here that's going to be more efficient in our factory. It's going to be more resilient in the supply chain and then we're going to -- and the customers are going to get more value from a broader torque range and lower form factor. And so that's the kind of work that's going on in Industrial right now. So that's why I think it's the middle innings because we've kind of evolved from -- these are the things we want to stop and these are the things we want to keep doing. And now we're just refining the approach within the places we want to compete.

And Chip, if I can add to that, Gautam, as you're talking about where can it go? As Chip has spoken about previously is we're focused heavily on recouping our service franchise there. And we've got to see -- we have a plan. We got to see what's the art of the possible is and how we can get there. But I think that will -- if we're in the middle innings, we've got half game to call on the productivity, the other piece of margin expansion will be how we can grow that service franchise. And I think we can talk more about that when we get to Investor Day and what's the art of the possible for industrial margin rates.

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

Thank you. I'd just like to thank everybody for joining our 2Q call and look forward to talking to you again soon.

And ladies and gentlemen, that concludes our conference call today. A rebroadcast will be available at the company's website, www.woodward.com for 1 year. We thank you for your participation in today's conference call. You may now disconnect.