Woodward, Inc. Q3 FY2022 Earnings Call

Thank you, Operator. We would like to welcome all of you to Woodward’s third quarter fiscal year 2022 earnings call. In today’s call, Chip will comment on some of his initial observations after joining Woodward, as well as our market-related strategies. Mark will then discuss our financial results as outlined in our earnings release. And 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 August 15, 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 would like to refer to and highlight our cautionary statement as shown on slide three. 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 supply chain and labor disruptions, and net inflationary pressures. Those elements can and do frequently change. Please consider our comments in light of the risks and uncertainties surrounding those elements including the risks we identify in our filings. 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 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 third quarter, net sales for the third quarter of fiscal 2022 were $614 million, compared to $557 million, an increase of 10%. Net earnings were $39 million or $0.64 per share, compared to $49 million or $0.74 per share. Net cash provided by operating activities for the first nine months of fiscal 2022 was $86 million, compared to $318 million. Free cash flow for the first nine months of fiscal 2022 was $49 million, compared to $297 million. Adjusted free cash flow was $52 million. Now, I will turn the call over to Chip to comment on his observations, as well as further commentary on our results, strategies and markets.

Thank you, Dan, and good afternoon, everyone. Before we discuss the quarter, I wanted to share some observations from my first few months as CEO. During this time, I met with customers, visited many of our production facilities and engaged with team members. I am impressed by what I have seen so far. I am energized by the role that Woodward has played in helping to solve our customers’ fuel and motion control challenges, resulting in improved fuel efficiency and reduced emissions in both Aerospace and Industrial applications. Woodward has and will continue to develop new technologies to reduce fuel consumption and associated emissions. In addition, our newest R&D efforts executed alongside our customers are enabling a wide variety of clean fuels to power the engines of tomorrow. These efforts are enabling multiple paths to a cleaner, decarbonized world, and I am excited about the opportunities ahead of us. Drawing on my industry leadership experience, I am focused on four main areas: customers, products, operations and our members. Woodward has deep longstanding customer relationships that allow us to collaborate at component or systems levels and help customers solve some of their most challenging problems. I am impressed by our engineering expertise, our technology portfolio and our product roadmaps. Over the last decade, we have executed aggressive growth strategies to win significant chipset content on some of the most successful platforms in the Aerospace and Industrial markets. Several years ago, Woodward introduced the Woodward production system. Our company’s approach to the lean enterprise journey, we have some showcase facilities and our talented members are engaged in continuous improvement. As a result of our approach, significant value has been delivered to customers and returned to shareholders. My assessment so far is that we still have a fair amount of variation site-to-site and our sites are at different levels of maturity on their lean journeys. This is an area of opportunity for us across the board for safety, quality, delivery and cost improvements. Enhancements in these areas will benefit our customers, shareholders and members. Woodward also has substantial machining capabilities and a history of producing complex, precision-engineered components and systems. We can further leverage this capability to improve quality, delivery and cost in the near future. We have the opportunity to selectively dual source critical components and relieve capacity constraints in our supply chain, which should reduce lead times and solve some of the challenges we face today. While we largely have the equipment in place, this approach puts more pressure on hiring, training, and retaining talent, but we believe it will set us up for long-term sustainable success. We are already increasing investment in our members to enable superior performance and have ramped up our recruiting and hiring efforts. We continue to prioritize developing our members and helping them build a career at Woodward. Turning to the third quarter, the team delivered double-digit sales growth in a challenging operating environment. Orders are up in nearly all market segments, and our backlog has grown, but we have not been successful at reducing our past-due commitments to customers. This is due to a combination of part shortages from suppliers and inefficiencies associated with newly hired production workers. This is one of the most complex operating environments that we have seen. Our continued investments in the next-generation of machinists and technicians will be a key element in resolving these complex challenges and improving on-time delivery, increasing production velocity and lowering cost of goods sold. Profitability was negatively impacted by ongoing global supply chain and labor disruptions, increased material and labor inflation, and foreign currency exchange rates, all of which had a larger than expected impact during the quarter. We don’t expect these issues to improve substantially during our fourth quarter, and as a result, we are reducing our fiscal year outlook. However, demand is robust in nearly all market segments. Orders are not lost and our sole source positions are intact. Our long-term outlook remains strong. Mark will provide more details on the financials in a few minutes. Moving to our markets, rising global passenger traffic is driving increased utilization of commercial aircraft fleets; U.S. and European domestic passenger traffic is nearly at pre-COVID levels and China domestic passenger traffic is now rebounding. International travel continues to improve as well. In the defense market, we expect U.S. procurement to increase slightly in the near term, and geopolitical tensions may lead to an increase in our national defense spending. In power generation, demand for industrial turbo machinery is driven by strong growth in Asia. Global aftermarket activity continues to increase and demand for backup power at data centers remained strong. In transportation, the global marine market is strong, with increasing ship build rates, higher utilization and elevated transport pricing, all of which drive current and future market activity. Demand in China for natural gas trucks remains at depressed levels. The oil and gas market is favorable as prices and equipment utilization remain elevated, both of which are driving higher rig counts and should result in additional capital investment and increased aftermarket demand. In summary, we believe our markets will remain strong; increased demand signals for fiscal year 2022 and 2023 continue to be received from our customers. We are focused on improving operations to mitigate the challenges we face related to supply chain disruptions. We remain committed to delivering value to our customers and shareholders and positioning Woodward to capitalize on future market opportunities. I am excited to be here and I am energized by the bright future ahead for the company. I will now turn the call over to Mark to review our quarterly results and our revised fiscal year outlook.

Thank you, Chip. Our Q3 sales and earnings continue to be negatively impacted by the supply chain and labor disruptions, as well as labor inefficiencies. We anticipated these disruptions and inefficiencies would improve during the quarter, but they did not. They have persisted longer than anticipated and have had a more significant impact than expected. We anticipate these headwinds to last into 2023. Net sales for the third quarter of fiscal 2022 were $614 million, an increase of 10%. Sales for the quarter were again negatively impacted by approximately $100 million due to ongoing global supply chain and labor disruptions. Sales were also impacted by approximately $18 million from unfavorable foreign currency exchange rates. Aerospace segment sales for the third quarter of fiscal 2022 were $402 million, an increase of 18%. Commercial aftermarket and OEM sales were up 44% and 37%, respectively, driven by continued recovery in both domestic and international passenger traffic and increasing aircraft utilization as well as higher OEM build rates. The increase in segment sales was partially offset by delayed shipments of approximately $55 million caused by global supply chain and labor disruptions. Defense OEM sales were down 2%. Defense aftermarket sales were down 12%, primarily due to global supply chain and labor disruptions. Aerospace segment earnings for the third quarter of 2022 were $57 million or 14.1% of segment sales, compared to $53 million or 15.6% of segment sales. The increase in segment earnings was a result of higher sales. Segment earnings, including as a percentage of segment net sales, were negatively impacted by net inflationary impacts, including material and labor cost increases, as well as increases in manufacturing costs related to the supply chain disruptions and inefficiencies related to training new hires. We are taking pricing actions to address inflationary pressures. However, timing can be delayed due to certain contractual arrangements. Turning to Industrial, Industrial segment sales for the third quarter of fiscal 2022 were $213 million, compared to $216 million, a decrease of 1%. Unfavorable foreign currency rates negatively impacted segment sales in the third quarter by approximately $16 million. In addition, segment sales were negatively impacted by weakness in China natural gas engines, and global supply chain and labor disruptions delayed shipments of approximately $45 million. The negative sales impacts were partially offset by increased marine sales driven by higher utilization of the in-service fleet, as well as greater industrial turbo machinery sales supporting the increasing demand for power generation and process industries. Industrial segment earnings for the third quarter of 2022 were $21 million or 9.9% of segment sales, compared to $27 million or 12.6% 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 supply chain and labor disruptions and inefficiencies related to training recent hires. Similar to our aerospace business, we are taking pricing actions to address inflationary pressures. However, timing can be delayed due to certain contractual arrangements. Non-segment expenses were $19 million for the third quarter of 2022 compared to $14 million. At the Woodward level, R&D costs for the third quarter of 2022 were $32 million or 5.2% of sales, compared to $30 million or 5.3% of sales. SG&A expenses for the third quarter of 2022 were $46 million, compared to $48 million. The effective tax rate was 21.6% for the third quarter of 2022, compared to 16.8%. Looking at cash flows, net cash provided by operating activities for the first nine months of the fiscal year 2022 was $86 million, compared to $318 million. Capital expenditures were $37 million for the first nine months of 2022, compared to $21 million. Free cash flow was $49 million for the first nine months of fiscal 2022, compared to a free cash flow of $287 million. Adjusted free cash flow was $52 million for the first nine months of 2022. Adjustments to free cash flow for the first nine months 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 with inventory increases as a result of production delays due to supply chain and labor disruptions, as well as higher sales driving increased accounts receivable. Leverage was 2.0 times EBITDA at the end of the third quarter. During the first nine months of fiscal 2022, $462 million was returned to stockholders in the form of $34 million in dividends and $428 million of repurchased shares. Lastly, turning to our fiscal 2022 outlook, in light of the continuing global supply chain and labor disruptions and net inflationary impacts, we are revising our FY 2022 guidance as follows. Total net sales for 2022 are now expected to be between $2.35 billion and $2.40 billion. Aerospace sales growth is expected to be between 8% and 10%. Industrial sales are now expected to be approximately flat. Aerospace segment earnings as a percent of segment net sales are now expected to be approximately 15%. Industrial segment earnings as a percent of segment net sales are now expected to be between 9% and 10%. The adjusted effective tax rate is now expected to be approximately 17%. Adjusted free cash flow is now expected to be approximately $100 million to $120 million. Capital expenditures are still expected to be approximately $60 million. Adjusted earnings per share is now expected to be between $2.55 and $2.75 based on approximately $63 million of fully diluted weighted average shares outstanding. This concludes our comments on the business and results for the third quarter of 2022. Operator, we are now ready to open the call to questions.

Thank you. Our first question comes from Robert Spingarn with Melius Research. Your line is open.

Good afternoon.

Good afternoon, Robert.

Hello, Robert.

Yeah. Chip, a question about the commercial aftermarket, which is up 44% in the quarter, but it was flat from the March quarter to the June quarter if I have our numbers right. Can you talk a little bit about what happened there? Would have expected a sequential increase?

Rob, I'm unsure where to begin with that since I wasn't present for the March quarter. However, there is some seasonality to how we observe that business flow, with removals typically driven in the summer, which carries over into the later part of the year.

Yeah. In addition to that, Rob, the other side of this, and we have been talking about this for a little while now, it’s really around the deferred maintenance that’s been out there. The airlines did a really good job during the pandemic and coming out of the pandemic deferring maintenance as long as they could. And you did see good growth in our second fiscal quarter, and so we were seeing some of that coming through. It’s still coming through based on the utilization of the aircraft, but some of the timing may be a little different than what you would anticipate from quarter to quarter just based on when the airlines decided to do some of that deferred maintenance.

Okay. All right. And Chip, if I could ask a follow-up, perhaps to focus on your extensive background in the engine business, Airbus has some aggressive production targets out there, obviously, Boeing is doing what it can to get the narrowbody up and the 787 is going to come back here. But based on your experience, is it realistic to expect the engine OEMs to be able to meet these longer-term production targets? I am talking about 75 on the A320, that kind of thing. Is that going to happen by mid-decade?

I’d be speculating at best, Rob, on that, but these OEMs are very experienced and have a really good command of what their capacity is, and given time, investment and confidence, it’s just a matter of the will to put the capacity in place to serve that. There is a lot of discussion in the marketplace about if the rates go that high, can they be sustained? Is there enough demand to sustain them at that level for long enough to justify the investment? I think that really is a dialogue for the airframers and the engine OEMs to come to some conclusion and also look at the pinch points in the supply base and talk to folks like us and investment casting and other places where the investment is substantial to increase capacity. And if everyone gets their head around that there is a demand out there that’s long enough to justify the capacity increase, then there is a good return on that investment. But if people are worried that it’s a bubble or something that would be shorter-lived, then I have to be a lot of discussion about flattening that out.

Just to mention capacity and investment, just on a shorter-term basis, is the issue that we see today and particularly on the engine side one of capacity or is it a labor shortage? In other words, the capacity is there, at least to get the near-term rates this year, next year. The problem is labor, or do they really need to invest more or is that when you are talking about investment to get to the 25 rates?

I don't have a complete understanding of where the engine OEMs currently stand with their internal operations, but from our perspective and looking at our supply chain, it appears to be a mix of labor and material shortages, with minimal issues related to equipment or tooling. What I often notice is that one company may be facing material shortages while another has labor shortages when you examine one tier upstream. For Woodward, it seems the predominant challenge is a shortage of people somewhere in the supply chain. This could stem from the ongoing effects of the China lockdown, which prevented many from going to work, or it may be related to domestic sources struggling to maintain staffing levels ahead of attrition.

Okay. I think that distinction is really important. Thank you.

Yeah.

Your next question comes from the line of Pete Skibitski with Alembic Global. Your line is open.

Hey. Good afternoon, guys. Can we drill down deeper into Aerospace earnings this quarter? You saw some benefit from volume and we are talking about labor here, but you have been through a CapEx cycle. You have, I think, some of the more modern facilities in automation in the industry. So how come we are not seeing that benefit of automation yet at Aerospace?

We have noted in our prepared remarks the effects of inflation and labor inefficiency. Back in February, we mentioned the need to hire 100 new direct labor members each month for the rest of the year, and bringing them on board and training them will impact our earnings, which we are still experiencing. As Chip said regarding our capital, our facilities are highly automated, allowing us to produce at the rates we discussed. However, the key is having trained employees and machines ready to operate, and we are working on bringing them in and getting them up to speed. We've faced some attrition, including retirements, and we continue to see these challenges. So, as we bring new members onto the production lines and work on their productivity, we are feeling the effects of these short-term impacts.

And, you know, we actually have some site-to-site variability in terms of how much is automated on the machining. And so, if you go to a place like Rock Cut, you will see a lot of automation. If you go to a place like Santa Clarita, you might see a lot more manual participation in the machining process, and having trained labor ability to facilitate and efficiently get through making a quality part the first time and the target build rate for the shift is something that we are going to continue to put a focus on.

When you guys talked about net inflation, it seems like we have talked about that for at least a couple of quarters now. Should we assume or are you assuming that within a couple of more quarters, your pricing actions just start to take hold? So by, I don’t know, the second quarter of fiscal 2023, we should see some net inflation improvements hopefully?

Yeah. So, Pete, thanks for the question. That is a good story for us overall. We have talked about, we are able to realize the price, but the timing may be delayed. So generally let me break it into two buckets. The first being on our OEM side of our business, typically its contractual-based, industry-based pricing during the calendar year increases that we get. So what we saw on January 1, 2022, was a price increase, but that only has the 2021 inflation impacts. What we will see in January of 2023 is the industry-based pricing increases that we will get based on the 2022 inflation, which I think where everyone is aware, has been significantly higher than any preceding year in the last few decades. So that’s one price realization that we will see. In addition to that, we do have catalog pricing increases that we put in for our aftermarket, and that is both on parts and labor, and we have put that pricing increases in. However, some of it takes some time to flow through. For example, if we have purchase orders from our customers, we don’t re-price them. So, although we did start to see some price realization here during our third quarter, we would anticipate that price realization to grow as we go forward.

Okay. Thanks for the color, guys.

You are welcome, Pete.

Thank you.

Your next question comes from the line of Matt Akers with Wells Fargo. Your line is open.

Hey. Good afternoon, guys. Thanks for the question. I wanted to ask if you have any early thoughts on next fiscal year and given kind of the slower narrowbody ramp-up we have with Boeing and Airbus. On the other hand, I guess, maybe you guys had some catch-up work from this year. If you have any thoughts on just how to stack up relative to some of the long-term targets you set at the Investor Day?

Well, maybe those are a couple of different questions. I think it’s too early to really have any specific remarks about 2023, other than saying that the demand is strong and our customers' sentiments are positive. I mentioned in a note to all members this week that I have met two kinds of customers on the road as I have traveled around. One kind is upset because we are past due on deliveries. The other kind is worried that we are not expanding capacity fast enough to meet the 2023 demand, but we haven’t impacted them yet on being past due. So, I think the trend for 2023 on the demand side is quite strong, and we are very bullish about that. The challenge is that it’s such an unstable supply chain environment that we are focused on really getting our arms around that and making sure we understand that well enough before making any statements about what 2023 looks like. I will let Mark comment on anything from Investor Day.

Yeah. So, Matt, as we had discussed in Investor Day, we have the overall Woodward sales CAGR over the next five years at 9% and generally consistent across both segments. As Chip just mentioned, we do see demand is strong and so that wouldn’t be anything that we would be changing today. We will look forward to having that discussion in early calendar 2023 at the Investor Day.

Great. Thanks. And then, I guess if I could ask a little more detail on some of the supply chain disruptions, and I think chips was one that you highlighted at the Investor Day, as I think it was kind of the long pole in the tent. Is that getting any better or is labor kind of the bigger focus now, just if you could kind of touch on some of the individual components there?

Sure. The issues we encountered with the suppliers of computer chips for our printed circuit board assemblies have improved. We are implementing strategies like screening industrial and military-grade chip requirements against commercial-grade chips and substituting components to meet our bill of material needs during shortages. Additionally, we have collaborated with brokers to secure adequate supply. The primary focus has been redesigning our PCBAs to accommodate the higher volume chips currently being produced for automotive applications. To proactively address this, we are considering a quicker turnaround for product management redesigns to support these high-volume chips. We have also faced labor shortages with suppliers, and we are addressing this through various means, including insourcing and dual-sourcing for machining operations. Since the last conference call, we have alleviated approximately 20 supplier risks, although new ones have emerged, reflecting the ongoing challenges of the supply chain. One such issue involved raw materials impacting our Rock Cut plant, linked to the labor shortages and lockdowns in China that affected the shipping of ceramic insert parts. This problem is sourced three tiers away from us, but we are exploring alternative sources to ensure production continuity for the year. In summary, while many earlier issues have been resolved, new ones have surfaced. We are intensifying our efforts in the material supply chain and working diligently to bring more processes in-house to better control our outcomes.

Great. Thank you.

Yeah.

Yeah.

Your next question comes from the line of David Strauss with Barclays. Your line is open.

Thanks. Good afternoon and welcome, Chip.

Hey. Good afternoon. How are you, David?

Good. So I want to ask about the defense side of the business. It looks like from a sequence it was down year-over-year, but looks like from a sequential standpoint that the business actually grew. Have we hit bottom there on the defense side, mainly talking about the OEM side?

Yeah. The defense OEM side, David, is we have been talking about for some time now, right? The softening on the guided weapons, specifically the JDAM product line. We weren’t able to completely offset that with the rest of the guided weapons programs like Small Diameter Bomb and AIM-9Xs. Actually, as we have looked forward here, it is starting to stabilize. However, we do still anticipate some of the JDAM softness to continue as we go forward. But we do anticipate, and I think you have heard us talk about that we do anticipate that the defense OEM side of our business, excluding the JDAM impact, that we would expect to grow. And you obviously with the war in Ukraine and what some of our NATO allies may do, we would anticipate that that would be an opportunity for us as we go forward.

Okay. And Mark, any sense or indication when the JDAM portion actually bottoms out or hits zero for you guys?

Yeah, that would be great. I wouldn't say it's completely bottomed out or at zero. The Department of Defense orders give us a bit more visibility. As we've mentioned over the past few periods, there's always the possibility of foreign military sales orders for that program, which might not provide as clear visibility for us. That's consistently an opportunity based on what our foreign military partners might decide in the next couple of years. However, you can observe in the DOD budgets that there is still some weakening in the current ordering patterns.

Okay. And on free cash flow, it looks like your guidance doesn’t imply any sort of working capital reversal in the fourth quarter. I think year-to-date you seem like a $120 million or so increase in working capital. How would you expect some unwind from here? And then in terms of the Investor Day guidance, Mark, is the $2 billion over five years for free cash flow, is that still good?

So, I mean, let me take the shorter-term one. So, you are right, obviously, the investment in working capital has primarily been inventory. We have increased that significantly since the beginning of the supply chain disruption that’s impacted us well over $100 million, I think. What we would anticipate for the rest of this year, as you say, we don’t see much improvement with kind of the sales that we have in Q4. We do anticipate receivables to increase based on the timing on those sales. We may get a slight decrease in inventory as we ship that product out. But generally working capital would be pretty constant from where we sit at June 30th. As we look out to the future, one of the things we have talked about is a lot of these, as Chip even mentioned, our demand is strong. These sales are not lost based on the positions that we are in. So it’s just the timing of cash flow. And so, what we are looking at as we move over the next four-plus years is that approximate $2 billion that we talked about at Investor Day would still hold and it’s just a timing initiative as we go forward and we will look forward to again kind of given our thoughts along the five-year plan when we have our Investor Day in early calendar 2023.

All right. Thank you very much.

You are welcome.

Your next question comes from the line of Chris Howe with Barrington Research. Your line is open.

Good afternoon, Chip and Mark.

Hey, Chris.

Hi, Chris.

I wanted to follow up on your comments regarding the China region. You mentioned seeing some signs of recovery in Aerospace and some positive developments in the Industrial sector. Could you provide more context about China, considering the ongoing uncertainty in that area, and how we should expect its recovery to influence Aerospace margins? Specifically, how much is China impacting Aerospace segment earnings relative to your targets?

Well, I think it’s fair to say that we weren’t very positive on China, or we didn’t come across as very positive on China. So it’s very hard to predict. As you know, it’s not really market-driven; it’s driven by the government at the top, and so hard to predict using first economic principles. Our positive statement was really around Asia Power Gen and that’s not really China; I think that’s ex-China is what we are looking at there. We don’t have a good visibility to improvements in the natural gas truck market, so we are not calling any forecast for improvement there. We just have to wait and see. As far as the commercial aircraft, commercial airline traffic, we are seeing the start of that recovery, and what we are counting on is the government not to get in the way of that. For us, the opportunity there is if the 737 MAX starts flying again and carrying revenue passengers, we will look to opportunities for initial provisioning with airlines that take deliveries of the 737 MAX going forward. So that’s really where our opportunity is generating cycles. Therefore, the aftermarket is key with new aircraft being delivered there and initial provisioning for those airline customers that get a certain critical mass of planes in their fleet.

Okay, perfect. Then one quick follow-up. As I think about fiscal year 2023 to the extent to which you can comment, do you still anticipate kind of getting back to historical levels on a run rate basis? Maybe not so much in the early part of 2023, but as we get to the latter portion of 2023 to return to pre-COVID levels?

Yeah. What you mentioned is exactly what we talked about at Investor Day. Obviously, with the demand that we are seeing out there, we were anticipating that in Q4. We will be returning to pre-COVID levels. I would say with the demand that we are still seeing, we would still anticipate that.

Okay. Thanks for taking my questions.

You bet.

You are welcome.

Your next question is from the line of Gautam Khanna with Cowen. Your line is open.

Hello, everyone. I wanted to ask about the sales reduction and whether it suggests detrimental margins of around 58%. Is that correct? Also, regarding the $100 million arrears, what is the guidance for the fourth quarter, and when do you expect to resolve those? Should we anticipate a quarter or two of above-normal shipments?

So to answer the first question, the volume decline and the impacts thereof, it does come down to be fairly, I believe your math 50% is in the ballpark definitely. But really a lot of that’s off the back of both the inflation impact on material and labor and also the labor inefficiencies, as I have mentioned earlier, related to the new hire training and the impact that has related to training them and then putting them on the line and trying to get those numbers up and productive. The other impact in the quarter that we had and it’s primarily the euro was the FX impact, and that’s really to say, I call a translation impact. It’s just translating our euro-based business that has revenue and costs in euros and that has an impact when you translate those over the dollars when the dollar is almost at par with the euro, which it hasn’t been in almost 20 years. So that’s definitely within the quarter, the impact that we had. Related to the supply chain disruption, what we mentioned is we do plan on that continuing into 2023. As Chip mentioned, obviously, we have a lot of activity. We have redeployed a lot of resources; we have a lot of suppliers that are in our escalation program that we are working with on a daily and weekly basis, but we don’t plan for that to be until 2023.

Understood. We should not expect to add $100 million or $150 million, or any other variances from the original guidance to next year. It will still be a gradual process.

Yeah. Gautam, I think the fact of the matter is that there is not enough capacity to just sort of shoot out all that past due. It’s going to happen to burn down over the year 2023. I think it’s still being potentially aggressive to say we get everything out next year just due to the fact that I think we will be managing supply chain disruption externally and internally through 2023. So we will be doing our best to burn that down and we will burn it down; how much, I don’t know, but I think you can count on the fact that it won’t be a slug output in a single quarter.

Thank you, guys.

Yeah.

You are welcome.

Your next question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is open.

Hi. Good afternoon, guys. Thank you and welcome, Chip. Chip, since this is your first quarter...

Thank you.

...kind of a tough one for you. I think we could all agree that Woodward has done a good job in terms of organic growth and increasing EPS over the years, but the quarterly volatility is fun for us, not for the stock price. So what are your observations in terms of how you can maybe improve forecasting if you have any yet?

Well, I am not sure about forecasting, Sheila, but one of the things that I think drives some variation quarter-to-quarter is operational performance. And so at least that’s the thing I have seen in my brief, less than 90-day tenure as something to work on. I really think that’s an area to focus, to develop excellence internally as well as maybe add a few resources to the team in the lean continuous improvement arena. So I think that’s really the focus there is to get a very predictable delivery and quality performance, and that will help us have a lot of confidence around the financial numbers that we put forth.

Okay. Thanks for that. And then, on just the Aerospace margins, when we look year-over-year, revenues are up almost 20%. Sequentially they are up 10%, but yet your EBIT dollars are flat with the prior year and almost the prior quarter, like, so what sort of drove that margin in the quarter? We have talked about labor since February and supply chain for several quarters now. So what kind of got worse in the quarter?

We have discussed the effects of labor and material inflation throughout the year. Earlier, we indicated that we wouldn't be able to achieve productivity gains to offset these inflations. The rise in inflation during Q3 negatively affected our year-over-year earnings. Additionally, we've been working on hiring and training new team members at an average rate of 100 per month for the remainder of the year. However, our attrition rates have increased slightly, which means we are currently behind our hiring targets. It's crucial for us to get new hires trained efficiently. Furthermore, on the Aerospace side, Chip mentioned the impact from earlier disruptions related to the China shutdown, which continues to affect our production capabilities and overall earnings. The slowdown in volume output and efficiency directly contributes to this.

Okay. That makes sense. And then the last question for you, Mark, when we think about your contracts in Aerospace again, where are you falling behind in place? When we think about commercial aero defense, helicopters, jets, and on the OE and aftermarket side, where are you headed?

Yeah. The biggest impact in the short term is definitely been on the commercial OEM side. I mentioned earlier on the call that generally the contracts are in the sea-based increases on a calendar year. And so as the first half of this calendar year, the inflation has been significant, we have not been able to re-price those at this point. Again, it’s just a timing difference that we will be able to realize those prices; we will realize them in the January timeframe, but that’s definitely the largest impact that we are seeing.

Okay. Awesome. Thank you.

Okay. You are welcome.

Your next question comes from Michael Ciarmoli with Truist Securities. Your line is open.

Hi. Good evening, Chip, Mark. Thanks for taking the questions. I guess just if we went back to last quarter, it sounded like the guidance then was assuming any recovery in the supply chain, but obviously the outlook got significantly worse. And I guess even Industrial, the revenue down significantly; did the China nat gas? I thought I was under the impression that was kind of baseline. But I guess what significantly got worse on the Industrial side of the business to drive this drastic of a change on the revenue equation?

I'll provide an overview and then focus on the Industrial sector. Our previous forecast at the lower end was based on the assumption that supply chain disruptions would improve. However, with just one quarter remaining, it's clear that the situation has not improved, as Chip mentioned regarding the ongoing challenges we're facing. The impact of these issues includes a range of inefficiencies, persistent inflation, supplier disruptions, and related costs. Chip also noted that we have over 20 suppliers currently undergoing significant escalation processes, which requires us to redeploy personnel and engineering resources for redesigns. This has led to substantial costs. Specifically for the Industrial segment, the most significant individual factor impacting us is currency fluctuations. It's important to clarify that this is not primarily related to China. As we discussed last time, we expected the OH market to remain stagnant for the rest of this fiscal year, which has indeed occurred. The main issue was the impact of the euro on our business, particularly with our L’Orange acquisition from 2018, which is euro-denominated. Unfortunately, the currency exchange rate between the euro and dollar is offsetting any growth we are experiencing in other Industrial markets, which is why we are effectively flat for this year.

Got it. That’s helpful. And then maybe just one other one back to Gautam. I think it was Gautam who was asking this question about picking up this $100 million. What would be the biggest governor on capacity? I mean pre-COVID, in Aerospace you guys did $1.9 billion, and we are doing quarterly revenue close to $500 million. Is it labor? Would that be the biggest chokepoint in capacity? I mean, obviously, you just mentioned other suppliers and materials. But, certainly, you have done $500 million revenue quarters before. So, what would be the biggest hold-up to getting there and getting more products out the door?

It’s labor, Michael. I mean, our labor and our supplier’s labor is really the biggest, to use your word, governor on the ability to increase throughput. We are putting new strategies in place on development pipelines and bringing people on board that are somewhat qualified, and we will train the rest of the way as far as machines go and assembly technicians. The rest, there’s additional labor categories like programmers for CNC machines and things like that, when you think about how to get a high mix, low volume through some of the lines, you need some of these talents as well. I mean, that’s with both us and our supply base. We are going to work to attack that part of the problem, but that’s really the biggest constraint.

That’s helpful. And then just the last one, as we look to maybe about January 2023 price increase environment, do you guys expect that you can get sort of a real price increase there, or is this going to be price increases that are just going to offset the headwinds from inflation and maybe won’t be that accretive to margins?

The January 1 pricing is based on contractual agreements tied to indices, which primarily serves to counterbalance the cost increases we're experiencing throughout 2022. As you're aware, our aftermarket pricing reflects our strong market position and significant intellectual property. Given our role in the aerospace sector, particularly with engine components, we anticipate more opportunities for price increases beyond just addressing costs.

Perfect. Thanks, guys.

You are welcome.

There are no further questions at this time. 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 1-800-770-2030 for a U.S. call or 1-647-362-9199 for a non-U.S. call, and by entering the access code 4278216. A rebroadcast will also be available at the company’s website, www.woodward.com. We thank you for your participation on today’s conference call and ask that you please disconnect your line.