Earnings Call Transcript - WWD Q3 2025

Operator, Operator

Thank you for your patience. Welcome to the Woodward, Inc. Third Quarter Fiscal Year 2025 Earnings Call. Please note that this call is being recorded for rebroadcast. Joining us today are Chip Blankenship, Chairman and Chief Executive Officer; Bill Lacey, Chief Financial Officer; and Dan Provaznik, Director of Investor Relations. I will now hand the call over to Dan Provaznik.

Daniel Provaznik, Director of Investor Relations

Thank you, operator. We'd like to welcome all of you to Woodward's Third Quarter Fiscal Year 2025 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've 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.

Charles P. Blankenship, CEO

Thank you, Dan. Good evening, everyone, and thank you for joining us. We're pleased to report strong third quarter results that exceeded our sales and earnings expectations. This strong performance was driven by ongoing robust demand across both our Aerospace and Industrial segments, along with disciplined execution by our global teams. Our members remain focused on safety, quality, delivery, and cost improvements, with safety always coming first. While our traditional safety metrics are currently world-class, we are focused on making Woodward the safest work environment through our Human and Organizational Performance program, also known as HOP, which we rolled out to seven more sites this year. The new sites are embracing the program and growing their capability to identify risks, add layers of protection, and use HOP learning teams to solve more complex problems related to workplace safety. We also play a role in the safety of our customers' products, and we are laser-focused on ensuring that we meet the product safety and quality requirements our customers are counting on from Woodward. Looking at a few highlights from our third quarter financial results, Woodward posted record sales, up 8% year-over-year, and earnings per share came in at $1.76, up 8% year-over-year. Aerospace also had record sales, up 15%, and Aero margins expanded 140 basis points to 21.1%. In Industrial, our reported sales declined 3%. When China on-highway and the divested combustion product lines are excluded, Industrial delivered double-digit growth. Our year-to-date performance reaffirms our midterm and long-term growth trajectory as we strengthen our capability to meet sustained demand across our markets. Based on our strong year-to-date performance, increased macro environment clarity, and expected sustained growth, we are raising full-year sales and earnings guidance. Bill will take you through more details on that and other changes to our guidance. I'm also excited to share updates on two important milestones for Woodward. At the Paris Air Show, we held an event with Airbus to announce that we've been selected to provide spoiler control actuators for the Airbus A350. This is a major achievement for Woodward and is our first actuation line replacement unit win for a primary flight control surface on a commercial platform. The A350 spoiler award enables us to apply our deep expertise in military hydraulic flight controls to a very important and already successful key commercial aircraft program. In addition to OEM chipset delivery, the program includes a sizable installed base with long-term service opportunities, including for our own hardware and strategic upgrades to legacy configurations. It is also significant because successful execution on this opportunity will position us to be competitive on the next single-aisle aircraft. This win with Airbus is a key component of our long-term hydraulic flight control growth strategy. To support that growth, we're investing in a new manufacturing facility for the A350 spoiler actuation production in the U.S. We'll be able to share more details on the location as agreements are finalized. What I can tell you is that we're designing a showcase facility, vertically integrated, highly automated, including special processes, and built on the lessons learned at our Rock Cut facility during the LEAP and GTF programs. It's a significant yet manageable investment that will be spread over multiple years and is fully aligned with our organic growth strategy. The A350 spoiler facility is a perfect example of how we're investing in ourselves for the highest return. In addition, last week, we completed the acquisition of Safran's North American electromechanical actuation business. This is a key inorganic play that places us at the heart of industry-leading horizontal stabilizer trim actuation technology, serving platforms including the Airbus A350, Embraer E175 and E190-E2, Gulfstream 650, 700, and 800 and Dassault Falcon 7X and 8X. Together, these two strategic moves, one organic and one inorganic, strengthen our core capabilities and commercial aircraft pedigree ahead of the next single-aisle competition. These developments, along with our automation acceleration, will require increased capital allocation to CapEx in 2026 and 2027 as we invest in future growth and productivity. Turning to what's happening in our end markets, we remain extremely optimistic about developments that matter to Woodward. In Aerospace, supply chain challenges across the industry continue to impact aircraft deliveries, but air traffic is still growing globally. Airlines are optimizing load factors and fleet utilization to keep pace. Aero services exhibited sustained strong growth in the third quarter. The softening in services we had anticipated in our plans and guidance hasn't materialized, as airline customers continue to invest in their legacy fleets to ensure they have enough capacity to meet travel demand in the face of slower deliveries of new aircraft. In fact, legacy engine LRU overhauls for both narrow-body and regional aircraft grew compared to last year and show few signs of declining as yet. Widebody engine control system service demand remains steady. In addition, as I have mentioned in previous earnings reports, LEAP and GTF service activity continues to grow steeply but it is no longer doubling in size year-over-year as the base numbers grow. The great news is that LEAP and GTF revenue is now approaching that of legacy products and is delivering a meaningful impact to our Aero services growth profile. We expect service volumes to continue increasing through 2026 and 2027 as LEAP and GTF hours and cycles continue to drive service inputs. Commercial OEM was softer this quarter as airframers managed supply chain disruptions and all our customers managed elevated inventory buffers. Defense OEM was again a significant growth driver for Aero, as expected, led by strong performance in smart defense. The defense services environment overall remains solid, though inputs to Woodward have varied quarter-to-quarter. In Industrial, our gas turbine portfolio was a standout performer, particularly in LNG and broader oil and gas applications. Growing global electric power demand remains a key growth driver for our Industrial segment. Based on conversations I've had with customers, along with what we see directly in orders, we're getting confirmation that the growth predictions are real and we're prepared to serve that growth. We're focusing our lean transformation on capacity and lead time improvements on our model gas turbine control valve production line to better serve customers. In fact, we've increased output more than 30% year-to-date. We're more than halfway through the Glatten expansion project to increase capacity to meet data center backup power demand. With construction tracking ahead of schedule, we've ordered all remaining machines in July, and we will be ready to begin moving into the new hall in November. This value stream has been completely redesigned with 3P principles, that is production, preparation, and process. We are using this expansion opportunity to create better flow, introduce higher levels of automation, and improve inventory turns. In transportation, marine demand remains exceptionally strong. Shipyards are full and they continue to expand capacity. In the quarter, more than half of all new ship orders included alternative fuel specifications, which resulted in a strong pull for Woodward's solutions. As expected, demand for China on-highway heavy-duty trucks declined primarily due to local economic headwinds. Overall, we see continued momentum in the macro growth drivers across both our Aero and Industrial segments into 2026 and beyond. A few comments on the macro environment: we remain vigilant and agile as we navigate tariffs, geopolitical matters, supply chain dynamics, and other expected and unexpected external factors. Our focus is on developing even more resilience and continuing to serve our customers regardless of the external conditions we face. Based on our consistent performance, it's clear we're on the right path to deliver on the commitments we made to you. We will continue to create shareholder value through our value drivers of profitable growth, operational excellence, and innovation. Now I'll hand it over to Bill for more details on our third quarter financial performance and the specifics of our updated guidance. Bill?

William F. Lacey, CFO

Thank you, Chip, and good evening, everyone. As a reminder, all references to years are references to the company's fiscal year unless otherwise stated, and all comparisons are year-over-year unless otherwise stated. We delivered record net sales in the third quarter of 2025 of $915 million, an increase of 18%, reflecting the strong demand across our end markets. Earnings per share for the third quarter of 2025 were $1.76 compared to $1.63. At the segment level, Aerospace segment sales for the third quarter of 2025 were a record $596 million compared to $518 million, an increase of 15%. Defense OEM sales were strong in the quarter, up 56%, largely driven by increased demand for our smart defense programs. Commercial services sales rose 30%, exceeding our expectations, driven by both pricing and increased volume tied to continued high utilization of legacy aircraft, which is extending their current service cycles. As Chip highlighted, LEAP and GTF service activity continues to increase. Commercial OEM sales were down 8% as airframers navigated supply chain disruptions and all our customers managed inventory levels. We expect these headwinds to moderate as airframes continue to increase production rates in the coming quarters. Sales for defense services were down 16%. While the market demand environment is solid, the timing and flow-through of orders to Woodward can fluctuate considerably from quarter-to-quarter. Earnings in the third quarter for the Aerospace segments were $126 million. Margins expanded 140 basis points to 21.1% of segment sales. The increase in segment earnings was primarily driven by price realization and higher volumes, supported by our ongoing operational excellence and lean initiatives that enhanced output and efficiency. These gains were partially offset by planned strategic investments in our Aerospace manufacturing capabilities to meet our current and future growth. Inflation also contributed to the cost pressure. The margin rate was tempered by unfavorable mix, driven by growth in our defense OEM products, which carry lower margins relative to other parts of the portfolio. Turning to Industrial. Segment sales for the third quarter of 2025 were $319 million compared to $330 million, a decrease of 3%. This was primarily due to the expected decline in China on-highway sales, which were down $36 million or 69%. Our core Industrial sales, which exclude China on-highway, grew by 9% in the quarter. Oil and gas were up 16%, driven by price as well as volume related to increased activity in midstream and downstream gas investments. Marine transportation was up 16%, driven by both price and volume. Power generation was flat due to the impact of the divestiture of our combustion business in the second quarter of this year. Excluding that impact, power generation sales grew double digits. For context, the combustion business averaged approximately $50 million of sales per quarter. Going forward, the best way to think about our Industrial products and services portfolio is excluding China on-highway and combustion. As Chip highlighted earlier, using this view, Industrial grew double digits in the third quarter. Industrial segment earnings for the third quarter of 2025 were $48 million or 14.9% of segment sales compared to $60 million or 18.1% of segment sales. The decrease was primarily due to lower China on-highway volume. Looking at our core Industrial business, we expanded margins to 15.6% of sales, up approximately 90 basis points. This expansion was driven by our progress in operational excellence, including price realization across the portfolio and our ability to generate incremental margins from higher volumes. Given these strong results, we now expect Woodward's core industrial margin for the year to be approximately 15% of sales, the high end of our previous range. Non-segment expenses were $36 million for the third quarter of 2025 compared to $30 million. We expect adjusted non-segment expenses to finish the year close to the same rate that we have been running year-to-date. At the consolidated Woodward level, net cash provided by operating activities for the first nine months of 2025 was $238 million compared to $297 million. Capital expenditures were $79 million for the first nine months compared to $72 million. Free cash flow was $159 million for the first nine months of 2025 compared to $225 million. The decrease in free cash flow was primarily due to an increase in working capital. As of June 30, 2025, debt leverage was 1.5x EBITDA. During the third quarter, we returned over $62 million to stockholders, including $45 million in share repurchases and $17 million in dividends. Through the first nine months of 2025, we returned $172 million to stockholders, including $124 million in share repurchases and $48 million in dividends. We now expect to return approximately $235 million to stockholders in 2025, exceeding our initial goal of returning $250 million. This should consist of $170 million of share repurchases and $65 million in dividends. We will continue to manage this with flexibilities as conditions evolve. We remain disciplined in deploying capital across three priorities: reinvesting for growth, returning cash to shareholders, and selective returns-focused M&A. As Chip highlighted, we will be making a multi-year investment in a new state-of-the-art facility to support the Airbus A350 spoiler actuation win and long-term organic growth. In addition, the recent acquisition strengthens our position in electromechanical actuation systems and meets our strategy-driven deal criteria. These growth investments, along with our accelerated automation initiatives, will increase capital spend over the next couple of years as we invest in growth and productivity. We will provide more details on these capital allocation plans during our fourth quarter earnings call. Now turning to our 2025 guidance: We are raising our sales and earnings guidance, revising our adjusted effective tax rate down, and lowering our free cash flow range. We are reaffirming the other elements of our full-year guidance. This updated guidance reflects our year-to-date performance, a more stable macro environment, and strong fourth-quarter outlook. For 2025, we now expect consolidated sales of $3.45 billion to $3.525 billion, which includes Aerospace sales growth between 11% and 13% and a decrease in Industrial sales between 5% and 7%. Now we expect adjusted EPS between $6.50 and $6.75 with Aerospace margins to be between 21% and 21.5%, and Industrial margins to be approximately 14.5%. We now expect the fiscal year 2025 adjusted effective tax rate to be approximately 17%. We now expect our 2025 free cash flow to be between $315 million and $350 million. We are lowering the free cash flow range as a result of increased working capital to support higher sales during a dynamic supply chain and production environment. All other aspects of our guidance remain unchanged. This concludes our comments on the business and results for the third quarter of 2025. Operator, we are now ready to open the call for questions.

Operator, Operator

Our first question comes from David Strauss with Barclays.

William F. Lacey, CFO

Dave, before you jump in, I just want to make sure I clarify something. When I noted our third quarter sales of $915 million, I may have said 18%. I just want to be clear that, that is an 8% increase. Thank you, I'll turn it over to you, David.

David Egon Strauss, Analyst

Great. Jeff, I thought I heard you say that LEAP and GTF aftermarket volumes are now close to legacy volumes. Maybe I didn't hear that correctly. But I thought in the past, you talked about getting to those kind of levels a couple of years out from now.

Charles P. Blankenship, CEO

Yes. So thanks for the question, David. In fact, they were getting close last quarter. This quarter, they've just got into the same neighborhood, ZIP code range, still short of the legacy total volume. And we forecast the crossover, which is what we said before in sort of the 2028 time period. So we're still sticking with that as our outlook. The things that could make that happen faster are if the legacy fleet starts to see fewer hours and cycles. We'll see less investment as Boeing and Airbus continue to pump out the neos and MAXs to take the places of those aircraft. So right now, we're still calling 2028, but I do want the folks out there to know that LEAP and GTF volume is now having a meaningful impact on our commercial Aero services revenue and margin, and we're very excited about that.

Operator, Operator

Our next question comes from Scott Deuschle with Deutsche Bank.

Scott Deuschle, Analyst

Bill, can you walk us through what drove the sequential margin decline in Aerospace in the third quarter and then the drivers behind the implied Aerospace margin improvement in the fourth quarter?

William F. Lacey, CFO

Yes, Scott, thank you. When looking at the incrementals, they are around 30%. Typically, we aim for incrementals between 30% and 35%. I understand that the first half incrementals for Aero were in the 40s. The reason for the decline in those incrementals is that while we experienced strong growth in aftermarket, we also had significant growth in our defense original equipment, which has a lower profit margin. This unfavorable product mix led to the decrease in our incrementals. As you mentioned, based on our guidance for the fourth quarter, we anticipate our incrementals will return to the ranges we observed in the first half of the year. We still expect strong performance in defense original equipment, alongside our smart defense program, which is reflecting the price increases as we introduce the newer versions. Therefore, we expect sustained growth in defense original equipment with the pricing adjustments. We also anticipate another strong quarter in our commercial aftermarket business.

Operator, Operator

Our next question comes from Noah Poponak with Goldman Sachs.

Noah Poponak, Analyst

Lot of discussion of some new investments or maybe a few we hadn't fully calibrated here. So in the release, you also cite Aerospace investments impacting the third quarter margin. Can you talk more about what that was and why it seems like only one quarter? And then what are you actually spending $35 million to $50 million on in the free cash flow reduction? Can you be more specific there? And then how much and for how long are we talking about higher CapEx beyond this year and what's it for?

William F. Lacey, CFO

Yes, thanks for those questions. First of all, on the investments that we highlighted in our manufacturing space, it was not necessarily a hit to margin rate, more of a hit to margin dollars. But what those investments are, are to drive productivity. We are investing in our team leaders. We're investing in our operations supervisors, again, to work with our direct employees in order to help us to increase our activity. We are also adding manufacturing engineers that will better allow us to implement our automation and allow us to get to the productivity benefits that we're looking for. Finally, we're adding in supplier engineers to continue to work with our supplier base to make sure we can improve on those areas. The second part of your question is around free cash flow and us lowering our range there. And the simple answer is we are investing more in working capital, specifically inventory. As we look at the need to meet the demands of our customer in the mix that they're looking for and get it there on time and understanding the capabilities of our process, we made the decision to invest a bit more in inventory to allow us to do that. We continue to work that area. We are investing in resources and in processes and in systems so that going forward, we don't need to invest at those levels, and we expect that you will see that benefit as we get to 2026.

Noah Poponak, Analyst

Okay. And Bill, you have a few years in a row now where the full-year Aerospace margin lands higher than the prior year's fourth quarter, so the fourth quarter proves to be an exit rate that you build off of. The guidance implies the last quarter of this year will be in the mid-22s. Do we use that as the jumping-off point of what you expand next year?

William F. Lacey, CFO

No, not necessarily. Again, I think we are expecting to have a very strong Q4 in Aero. There's a few reasons for that. And as we get into 2026, we'll talk a little bit more about the rate that you can expect for Aero for the total year. But we're very pleased with where the implied 4Q exit of Aero.

Operator, Operator

Our next question comes from Scott Mikus with Melius Research.

Scott Stephen Mikus, Analyst

Nice win there, and you displaced an incumbent supplier on the A350's spoiler actuation system, and that makes you a Tier 1 supplier to Airbus now. So do you see other opportunities to displace incumbents on current platforms or is this more of a one-off opportunity? And then for future aircraft engine plans or programs, do you plan to pursue more work packages as a Tier 1 supplier? Or is the intention to primarily stay a Tier 2 supplier except where you have a differentiated offering?

Charles P. Blankenship, CEO

Yes, Scott, thanks for the question. As you probably know and most people in the industry know, displacements in the middle of really successful aircraft programs are somewhat rare, so we wouldn't view that as a wave of opportunities in front of us. But the combination of that opportunity and acquiring Safran's North American electromechanical actuation business allows us to get into the Airbus Tier 1 supplier structure, which we think is a great place to be as we look toward the next single-aisle aircraft opportunity. As far as Tier 1 and Tier 2 for us, we're kind of a little bit of a humble company. I mean, we're willing to do work at Tier 1 levels. We're willing and able to do systems, subsystems, or components, and where we can add value to customers and to products, we're willing to serve if we can make it a profitable high-return business for our shareholders.

Scott Stephen Mikus, Analyst

Okay. And then 1 quick one for Bill. Do you happen to have the pricing in the quarter? And can you perhaps parse that out by Aero and Industrial?

William F. Lacey, CFO

Yes, so the total business, we saw about 7% price. And I would say that Aero contributed a little more than Industrial, but both did a great job. We have said in the past that price for the year will be closer to 5%. Based on where we are, it will be closer to delivering 7% at the Woodward level for price for '25.

Operator, Operator

Our next question comes from Christopher Glynn with Oppenheimer.

Christopher D. Glynn, Analyst

Someone asked about the marine sector, which is performing better than previously discussed in terms of long-term potential, given the current industry capacity. I am curious about what is driving this improvement this year. It might just be pricing, but I also wonder if you are gaining market share or expanding your naval profile alongside commercial and merchant activities.

Charles P. Blankenship, CEO

Chris, I think the easiest way to think about how marine is going for Woodward is that our customers are taking share as well as the capacity increases and orders from the shipyards and the services business. So it's like those three things. It's price, it's the platforms that we're on, their winning positions on the ships, and then the service opportunity from the utilization is quite strong.

Christopher D. Glynn, Analyst

Okay, great. And then the third quarter, did that see any of the new lots pricing in the smart weapons?

William F. Lacey, CFO

It will start in the fourth quarter.

Operator, Operator

Tax rates come down a good bit, a couple separate times during the year. Just wondering what's driving that and if we should be thinking of a new baseline beyond the current year other than the kind of 20% anchor.

William F. Lacey, CFO

Yes. Historically, with the amount of stock options available to our members and the record stock prices we've experienced, we have benefited from those stock options providing us with a tax advantage. This is what has significantly lowered our tax rate. As we continue to grow our net earnings, we anticipate some pressure on our tax rate in the future. However, for now, the current stock price levels are allowing us to enjoy this benefit, which is leading to the lower tax rates we're seeing. This is also why we are revising our guidance for the effective tax rate for 2025.

Operator, Operator

Our next question comes from Gavin Parsons with UBS.

Gavin Eric Parsons, Analyst

Wanted to just parse out the working cap investment this year and the CapEx investment next 2 years. And how much of that is for, say, existing programs versus new wins like the A350 or maybe investing in the growth rate of the Safran business?

Charles P. Blankenship, CEO

Yes, Gavin, we can confirm that the increase in inventory is related to our current programs. This is a common topic in the industry and is influenced by fluctuations in our production system, varying customer demand due to supply chain challenges that may not directly involve us, and the impact of how our suppliers perform. We are cautious about making abrupt changes with our suppliers to retain the capacity we've developed since COVID. A lot of factors are at play, requiring careful management and strategic planning to ensure we can meet customer needs and manage demand effectively. Looking ahead to fiscal year '26, we believe we have the right expertise in place to address these issues and enhance our processes as we anticipate more stability in customer demands and the supply chain overall. We expect to see the impact of these efforts in the third and fourth quarters. Regarding investments, we are considering a facility for A350 spoiler production. These types of facilities typically require a budget of a couple of hundred million dollars, which can be spread over several years. We have experience in this area from building Rock Cut for the LEAP and GTF programs. While it's possible to construct a building for less, the price reflects the need for a highly automated and vertically integrated production system. Additionally, with our acquisition of Safran's electromechanical business, we will be transferring products to our existing facilities and optimizing our supply chain to better serve Airbus and other airframe manufacturers.

Gavin Eric Parsons, Analyst

Okay, that's great. I mean, just to put a finer point on the working capital, is that more to enable an acceleration in your growth or derisk your own supply chain visibility?

Charles P. Blankenship, CEO

It really does both, so thanks for that.

Operator, Operator

Our next question comes from Louis Raffetto with Wolfe Research.

Louis Harold Raffetto, Analyst

Bill, you ballparked quarterly sales rate for the Greenville divestiture. Could you speak to the impact to the Safran deal on results and then also what the cash usage was for this quarter?

William F. Lacey, CFO

Yes. For Safran, I think when it got announced, they sized the business. And we're focused on taking it, growing it, and at the end, improving it. But again, the key matter about this acquisition was a strategic one to allow us to continue to grow our capability in this space, and that's what we're focused on. Louis, what was the second part of your question?

Louis Harold Raffetto, Analyst

Just how much you spent on that deal? It will be in the K, was it just after the...

William F. Lacey, CFO

Yes. And again, it's a great deal for us and we're happy that we have it, and it's not something that we're covering right now.

Charles P. Blankenship, CEO

Yes. I think the reason we sized the Greenville for you is to help you, going forward, on what the Industrial and Power Gen compares look like. There's really no macro impact on Aero for that deal. So we're really not going to disclose that level of information on that small impact.

Louis Harold Raffetto, Analyst

Okay. And then maybe just latest on the China on-highway expectations for the rest of the year? I think you've gone from $40 million to $50 million. Are we at $70 million, I guess? Would love your top-down expectations.

William F. Lacey, CFO

We're approximately $60 million now, and in the fourth quarter, it will be around $10 million.

Operator, Operator

Our next question comes from Michael Ciarmoli with Truist Securities.

Michael Frank Ciarmoli, Analyst

Maybe Chip, can you give a little bit more color on this A350 spoiler win? I mean, in terms of what the expected chipset content will be, I guess, my understanding, you've got to develop your own IP. When maybe those first sales are going to occur? And any kind of expected margin profile you could talk to? It sounded like maybe the existing incumbent on this walked away, just given their return profile. And I guess a couple of hundred million of investment sounds kind of significant for just that one platform. Is this a broader play to position yourself for future kind of actuation spoiler wins on that next-gen narrow-body?

Charles P. Blankenship, CEO

Yes, Mike, thank you for the question. The spoiler actuator business is quite significant. The A350 program, based on Airbus's forecast for rate increases and the demand for that aircraft, is an excellent program to be involved in. There are 14 actuators, 7 per wing, and we have 12 of those, indicating a lot of hardware per chipset. This will require a fair amount of factory space since we will be vertically integrated. It is a considerable investment, but one that is manageable. We are exploring various options to enhance that facility moving forward. For now, we are optimistic about the investment and the anticipated return on the A350 program. We will continue to build on that and expand as we secure additional wins in the future.

Michael Frank Ciarmoli, Analyst

Will this be margin dilutive as it ramps up out of the gate?

Charles P. Blankenship, CEO

Often, programs can reduce margins, often due to fluctuations in production schedules and the timing of when the aircraft goes into production. However, in this instance regarding the displacement, we have a clear understanding of the rate we need to achieve and when. In response to your earlier question about when we expect to see revenue, both we and Airbus are aiming for a 2028 entry into service for our hardware.

Operator, Operator

Our next question comes from Sheila Kahyaoglu with Jefferies.

Sheila Karin Kahyaoglu, Analyst

Maybe just following up on the new facility. How do we think about the few hundred million? Is it '26 and '27 so $300 million over 2 years? And I know I'm making up numbers here. How do we think about the payback on that? And the commercial...

William F. Lacey, CFO

We expect this investment to be around a couple of hundred million dollars, primarily occurring in 2026 and 2027, with some potential spillover into 2028. We are very enthusiastic about this program and believe it will yield good returns for us, presenting an excellent opportunity with Airbus. We anticipate it will be a strong program.

Sheila Karin Kahyaoglu, Analyst

Okay. And then on the defense continued outperformance there, any comments you can make on how long it lasts? How do we think about the JDAM contract in particular and its impact on profitability?

William F. Lacey, CFO

Yes. First, regarding smart defense, I want to emphasize that all the products in our smart defense portfolio are performing well. JDAM, in particular, receives a lot of attention, which is deserved. These programs are challenging, but we are optimistic about demand through at least the first half of '26. Although it's cautious to predict beyond that, we remain confident about demand for the first half of '26.

Operator, Operator

Our next question comes from Gautam Khanna with Cowen.

Gautam J. Khanna, Analyst

I had a couple of questions. I'm curious if you addressed the situation regarding China's natural gas and what demand signals you're observing from those customers.

William F. Lacey, CFO

Yes. We've reinstated that Q4 will be around $10 million. The overall economy continues to dampen the demand and the order rate in that business.

Gautam J. Khanna, Analyst

Okay. Any preliminary view on 2026, given fiscal '25 has been an unnaturally low year? What is normal?

William F. Lacey, CFO

No. We're going to continue to focus on our core Industrial business, and that will be our focus. As we mentioned, it's a dynamic and volatile business, and we will share our perspective when we reach the end of the fourth quarter.

Gautam J. Khanna, Analyst

Okay. And big picture, have you seen any demand erosion from U.S. trade policy and all the changes we've had with U.S. trade policy since April anywhere in the portfolio?

Charles P. Blankenship, CEO

I wouldn't say we've seen a drop in demand. Instead, there has been some unusual volatility along with delays and spikes. Earlier this year, we experienced delays with service orders from China. Recently, we've seen a surge in orders, around one and a half to twice the usual amount, in the third and fourth quarters. While there has been this unusual volatility, I wouldn't describe it as a significant decrease in demand, nor would I label it as a long-term demand increase.

Operator, Operator

Our next question comes from David Strauss with Barclays.

David Egon Strauss, Analyst

So previously, you had this free cash flow target out through 2026 of $1.2 billion cumulative. Is that now off the table, given the reduction in the free cash flow forecast for this year and what you're talking about, it sounds like for CapEx next year?

William F. Lacey, CFO

Yes, David, I believe our underlying business and our plan still support delivering the $1.2 billion. However, you raised an important point regarding the CapEx spend for '26, which we are still working to define, and this could influence our forecast. We will provide more clarity on this by the end of the year.

David Egon Strauss, Analyst

Okay. And do you guys have any impact from or any benefit from Section 174 amortization going away as part of the Big Beautiful Bill?

William F. Lacey, CFO

Some elements of the bill related to our R&D expenses and the ability to accelerate depreciation of our facilities will be beneficial. While we have a general understanding of these aspects, we need more time to clarify how they will unfold. We will provide a clearer picture of the impact as we prepare to give guidance for 2026.

Operator, Operator

Our next question comes from Scott Deuschle with Deutsche Bank.

Scott Deuschle, Analyst

Chip, just to clarify an earlier comment you made, were you saying that LEAP and GTF aftermarket revenue is approaching legacy narrow-body aftermarket? or was the comment that total revenue from LEAP and GTF including OE is approaching legacy aftermarket? I just want to clarify that.

Charles P. Blankenship, CEO

Well, good clarification question. The point I was making was that in the aftermarket, in the service business, which is comprised of spare end items, repair and overhaul as well as spare parts, in those categories, that LEAP and GTF are gaining and getting into the same ZIP code as the legacy, which is very exciting for us.

Scott Deuschle, Analyst

Okay. And then Chip, when we think about growth in power generation over the coming years, should we be looking at the growth at GE Vernova and Rolls-Royce when we think about your growth? Or are there any specific nuances with respect to Woodward's position that would drive a meaningful divergence between what those OEMs are looking at and then what you might look at?

Charles P. Blankenship, CEO

I believe that overall, we are experiencing similar growth trends, but it can vary depending on which platform is more successful in specific applications. If a particular gas turbine or reciprocating engine gains traction, our hardware may or may not be included with those original equipment manufacturers. Generally speaking, an average across the OEMs would likely reflect what we're experiencing. Our product line focuses on gas engines, while our DFS business in Germany deals with MTUs for reciprocating backup engine power. Additionally, we supply numerous control valves for GE Vernova, Baker Hughes, and Mitsubishi gas turbines. By analyzing the performance and growth forecasts of these OEMs, you can understand how we fit into that marketplace.

Operator, Operator

Our next question comes from Noah Poponak with Goldman Sachs.

Noah Poponak, Analyst

Chip, in the beginning of the year in the initial guidance, if I recall, you had contemplated Aerospace aftermarket revenue growing low to mid-single digits. And year-to-date, it's now, I have it up 24%, I think that's right. The excess 20 points of growth, how much of that is pent-up demand, extended duration of the legacy fleet versus how much of that is sounds like maybe the LEAP and the GTF are coming along a bit faster than you planned at the beginning of the year?

Charles P. Blankenship, CEO

It is a combination of both factors, Noah, along with price. We see few signs of the legacy slowing down, which is a significant indication that we noticed earlier this year. I initially thought that growth would be flat, except for price increases. However, the shops and the airlines have managed to send more units for overhaul and repair and order more spare parts than we had forecasted. Additionally, the LEAP and GTF programs have continued to deliver more units for overhaul. We are pleased with the results. Earlier this year, when I was asked about potential demand, I noted that if demand increased, we would be ready with the capacity to take advantage of that opportunity, and that's how it has played out.

Noah Poponak, Analyst

Do you have a sense from those customers of how long that now goes into the forward? Or is it just kind of hard to have that visibility in that business?

Charles P. Blankenship, CEO

The challenge relates to revenue passenger miles and how long airlines will continue operating their older aircraft to compensate for slower delivery rates from manufacturers. When you listen to airlines like Southwest, United, American, and Delta discussing U.S. domestic travel, the outlook isn't very positive. However, demand in Europe and other regions appears to be improving. Keeping a close watch on that demand will help us gauge how long the legacy fleet will be heavily utilized. Once older aircraft are retired from the legacy fleet, more used serviceable materials will become available, which could quickly impact that market. On the Woodward side, the positive aspect is that there is a significant multiplier effect on LEAP and GTF as that fleet accumulates hours and cycles, reinforcing our growth outlook. However, we might be a bit ahead in anticipating a decline in the legacy fleet. It’s worth noting that a significant percentage of the CFM56-5s and -7s have yet to undergo their first shop visit, meaning those newer parts of the fleet still have plenty of operational time ahead. The older aircraft may be retired when demand shifts or as manufacturers ramp up production to desired levels.

Operator, Operator

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

Gavin Eric Parsons, Analyst

On LEAP, GE a week or two ago said they expect a 25% shop visit compound annual growth rate through the end of the decade. Anything to keep in mind about your growth rate relative to that?

Charles P. Blankenship, CEO

That's a notable growth rate. The hours, cycles, and utilization certainly back that up. Some of our line replaceable units don't directly align with shop visits. Although our growth rates are significant and steep, they don't necessarily match shop visits in terms of unit removals. Overall, we've found that the service content of the LEAP and GTF engines is five times greater than previous engine configurations. This averages out the differences in shop visit rates for items like fuel pumps and bleed air valves. Currently, we're observing pumps, fuel metering units, and fuel nozzles coming in, but we haven't seen many other products yet. Over time, that will change. However, I'm not sure if 25% is an accurate figure for us, as our correlation to shop visits isn't strong; we're more closely related to hours and cycles.

Gavin Eric Parsons, Analyst

That's helpful. And on JDAM, I didn't see the step up in the budget. Do you guys have that contract locked in? Or just wondering your visibility on that going forward.

Charles P. Blankenship, CEO

So we have purchase orders from our customer, and we're responding to those and fulfilling. I don't know what the locked-in you're referring to, but we have purchase orders from our customer.

Operator, Operator

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

Charles P. Blankenship, CEO

I would just like to thank everyone for joining us for today's call. We'll see you next time.

Operator, Operator

Ladies and gentlemen, that concludes our conference call today. A rebroadcast will be available at the company's website, www.woodward.com, for one year. We thank you for your participation in today's conference call.