Thank you for standing by. And welcome to the Woodward, Inc. Third Quarter Fiscal Year 2019 Earnings Call. At this time I would like to inform you that this call is being recorded for re-broadcast and that all participants are in a listen-only mode. Following the presentation you will be invited to participate in a question-and-answer session. Joining us today from the Company are Mr. Tom Gendron, Chairman and Chief Executive Officer; Mr. Bob Weber, Vice Chairman and Chief Financial Officer; and Mr. Don Guzzardo, Vice President of Investor Relations and Treasurer. I would now like to turn the call over to Mr. Guzzardo.

Thank you, operator. We would like to welcome all of you to Woodward's Third Quarter Fiscal Year 2019 Earnings Call. In today's call, Tom will comment on our markets and related strategies, and then Bob will discuss our financial results as outlined in our earnings release. At the end of our presentation, we will take questions. For those who have not seen today's earnings release, you can find it on our website at woodward.com. We have again included some presentation materials to go along with today's call that are also accessible on our website. An audio replay of this call will be available by phone or on our website through August 19, 2019. The phone number for the audio replay is on the press release announcing this call as well as on our website and will be repeated by the operator at the end of the call. I would like to refer to and highlight our cautionary statement as shown on Slide 3. As always, elements of this presentation are forward-looking or based on our outlook and assumptions for the global economy and our businesses more specifically. Those elements can and do frequently change. Please consider our comments in light of the risks and uncertainties surrounding those elements, including the risks we identify in our filings. Woodward adopted the FASB Accounting Standards update number 2014-09 revenue from contracts with customers or ASC 606 effective October 1, 2018, and results for the third quarter and first nine months of fiscal 2019 including adjusted and organic amounts are presented on that basis except as specifically stated otherwise. Prior period amounts are presented under the previous accounting standard, ASC 605. We believe the impact of adoption of the new standard will not be material for the full fiscal year, although there will be…

Thank you, Don. Welcome to all of you joining us today. Our performance during the third quarter of fiscal 2019 reflect solid fundamentals in both of our segments. In Aerospace, we delivered strong results despite continued uncertainty surrounding the prolonged Boeing 737 MAX grounding while our Industrial segment demonstrated further year-over-year improvement in the face of headwinds related to our renewables business. As a result, we believe we will finish the year with sales and earnings in the upper end of our previous guidance. Now moving over to our markets. Our Aerospace segment continues to perform well on the back of a strong market coupled with the healthy narrow-body production ramp, increased market share, and solid global passenger growth. Although the Paris Air Show was a little more subdued than prior years, we still added significantly to our backlog and have content on virtually all aircraft ordered. The test [ph] demand for Woodward programs continues to strengthen on the back of increased military budgets. Defense OEM and aftermarket performance was driven by continued strength in fixed-wing aircraft and guided weapons. With regard to the grounding of the Boeing 737 MAX, we're experiencing softer initial provisioning as anticipated. As of today, we are supporting OEM production rates. Given what we know, we do not anticipate a significant impact related to the grounding, but we will continue to monitor the situation closely. In spite of this matter, our Aerospace segment continues to deliver excellent financial results. Turning to our Industrial markets. Within power generation, large natural gas engines and clean burning diesel engines are gaining market share due to their lower emissions and increased efficiency. The Industrial gas turbine market continues to stabilize, and as it recovers our share gains and increased content will allow us to grow faster than the market.…

Thank you, Tom. Aerospace segment net sales for the third quarter of fiscal 2019 were $499 million, compared to $405 million for the third quarter a year ago, a 23% increase. Aerospace segment sales benefited from both Commercial, OEM and aftermarket as well as military OEM and aftermarket volume. The third quarter of 2019, which is reported under ASC 606, included $51 million of Aerospace segment sales that would not have been recognized under ASC 605, primarily due to customer provided components. Commercial aftermarket sales were up 9% compared to the prior year quarter. As anticipated, initial provisioning was lower due to the grounding of the Boeing 737MAX and compare it to a very strong third quarter in the prior year. Legacy aftermarket showed continued growth more in line with historical trends. For the full year, we anticipate Commercial aftermarket growth to be approximately 15%, which includes the impact of customer provided inventory as required under ASC 606. Aerospace segment earnings for the third quarter of 2019 were $103 million, compared to $84 million for the same quarter prior year. The increase in Aerospace segment earnings was largely driven by the higher sales volume. Segment earnings as a percent of segment sales were 20.7% for the third quarter of both 2019 and 2018. Turning to Industrial. Industrial segment net sales for the third quarter of fiscal 2019 were $253 million compared to $184 million in the prior period. Organic Industrial segment net sales for the third quarter of 2019 were $175 million compared to $159 million in the prior year quarter, a 10% increase. The prior year quarter included one month of Woodward L’Orange sales. Foreign currency exchange rates had an unfavorable impact on organic sales of approximately $6 million for the third quarter of 2019. On a constant currency…

Thank you. [Operator Instructions] Our first question comes from Sheila Kahyaoglu with Jefferies. Your line is open.

Hi. Good afternoon, guys, and thanks for the time.

Hi, Sheila.

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

Yes, a couple of things. One, obviously, the grounding of the MAX is one of the uncertainties, but really a lot of the growth and that's what we tried to call out is really related to ASC 606. And so, it's the non-cash consideration or customer-provided components that don't carry earnings. So that's a part of the growth that we're seeing. The aftermarket has been strong. It has come down a bit in the third quarter and in the fourth quarter, and a lot of that also is related to 606.

Okay. Thanks for the clarification. And then, Bob, another one for you on free cash flow, it’s been Q4 weighted up year-over-year, so what are you looking for to meet the $300 million target for the year?

Yes, it'll be a tight target, but we're confident that we've got a real shot at it. As you know, we had stronger sales in the first three quarters of the year than our normal pattern has dictated and that's largely on the back of strong first quarter for L’Orange. So we anticipate that a lot of that cash will come in the fourth quarter, so that will also cause some increase overall in working capital. And then in relation to the soft fourth quarter on our China vehicle sales, we believe that we're going to see some bank draft maturities in the fourth quarter that will also add to free cash flow in the quarter. And lastly, a little bit lighter on CapEx in the quarter, and all of those things kind of combining to give us some confidence on having – delivering a really strong fourth quarter and hitting the $300 million.

Great. Thank you for the color.

Sure.

Thank you. And the next question comes from Chris Howe of Barrington Research. Your line is open.

Good afternoon, everyone. Great quarter.

Thank you.

I had two questions here; one just touching on the Industrial segment and the second on Aerospace. In regard to the Industrial segment, can you perhaps parse out or break out some in more detail the industrial growth that you saw by end market, excluding L’Orange? And then just following up on that quickly, as far as the wind turbine manufacturer, is there any sort of timeline for this resolution? And how should we think about its magnitude or its percentage of mix for the renewables business?

Sure. Let me start with the last one first. So the timeline is a little bit uncertain. We've already passed one day when we were promised further information. And the information that's been given so far is fairly unclear. They've kind of outlined a lot of different options, but some of them won’t have a very dramatic impact on our business from dramatic impact to no impact. So they are currently calling out a September date for further information. And so, that's what we know with respect to what the courts and so on may announce. To give you some idea or perspective, you will see in the Q where we break out in desegregated revenue that our renewables business is approximately $14 million in sales in the quarter. That kind of gives you an idea of where we'll end up for the full year. It won't be a significantly larger fourth quarter, so somewhere in that $50 million to $60 million range. Senvion has gone from about 30% in last year's renewables sales to less than 10% in 2019. So, it's been a dramatic drop. And so, from – you can tell from that number, it's not as significant as it used to be. And so, it would not have a significant impact on Woodward, but would have a significant impact on the renewables business. So, we're watching closely to see what happens there. With respect to color on the other parts of the business, the Industrial business in particular, we saw some nice growth this quarter because of that pre-buy in the small natural gas engine space. Large gas engines have been doing very well. Large diesel engines, particularly those that have Woodward fuel systems that are clean burning have been really solid. Industrial gas turbines have been stabilizing. We saw a little bit of increase. I would not call that a trend necessarily yet, but we are encouraged that it has not gone down and 2021 – 2020 and 2021 looks positive in terms of what our long-term view is. Obviously, the wildcard is the renewables business and we'll have to see where that goes.

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

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

Okay. That's all I have right now. Thanks again for taking my questions.

Thank you.

Thank you.

Thank you. And our next question comes from Robert Spingarn of Credit Suisse. Your line is open.

Hey, guys.

Hey.

The accounting makes it a little bit tough to follow all this, but I'm trying to figure out if there's some conservatism as I try to reconcile the guidance, with the earnings guidance against the revenue and margins. And I'm wondering if it happens in non-segment expenses, what happens there? Because unless there's a market uptick there above the high-end of your range by not a small amount.

Well, you're correct kind of on both fronts. And don't hold me to the half of it, 50-50 sort of thing. But there is an impact related to 606. We do anticipate that in the fourth quarter that could be a headwind to us, and all just a function of what orders do we receive in the quarter and what earnings are we able to recognize over time in that quarter. And so we do anticipate that could be a headwind. On the operational side, it really kind of comes down to the impacts of the 737 MAX grounding. We don't really know what we've seen in the news that you guys have seen in terms of what the impacts could be. Tom mentioned that we are currently supporting their production schedules and kind of remains to be seen where that goes. So that's still some uncertainty. Chain trade and the impacts for the last few days and few months are also a point of uncertainty for us. And really the extent of pre-buy and what impact that may have on natural gas vehicle sales in China. And then lastly, the renewables business; so yes, there is some conservatism, there's some uncertainty, I would say related to all of those events, including the accounting issues associated with it.

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

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

Okay. And then just one for Tom, high level, saw the 777X and the GE9X in potential delays there. To what extent is, yes, could this develop into an issue?

Well, I think the issue we would have is, just the later introduction into service. Obviously, that would impact sales and obviously those early sales include initial provisioning. So, as we're watching that, we're putting together a long range plan and outlook. We're going to have to push out some of that forecast, but long-term I think 777 acts as a great program and it will materialize I think as planned, but it'll be a little delayed.

Okay. Thank you.

Thank you.

Thank you. And our next question comes from Pete Skibitski of Alembic Global. Your line is open.

Yes, hi, guys.

Hi, Pete.

A couple of follow-ups, maybe for Bob first. Bob, just the way corporate expenses are running – to following to Rob's question, it is looking like over $100 million on the corporate expense line for this year. And then should we think directionally it should be down next year just on the lack of Duarte costs?

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

Okay. Okay. And then on the cash flow, you're just done a pretty big receivables build this year. Is that – we kind of mentioning earlier on the call, is that mostly China and are we nervous at all about collecting that in the fourth quarter?

No, no nervousness about collection. Actually, it's kind of the other way around. We've talked about backdrops and so on and we've never had any issues with them. They worked just like cash, but they have a longer term on them. So we anticipate we'll see some net maturities in the fourth quarter, which is why that's a positive. And those net maturities are caused by the fact that because of the pre-buy, we think that the sales during the quarter will be down a bit in the fourth quarter. So – and we did, it wasn't only the sales – the accounts receivables, excuse me, impact so far has been. L’Orange has increased that as well. So they had a very strong first quarter. And then in general, the business has had strong first and second quarter strength. And so we see some of those receivables coming back down again in the fourth.

Okay. Got it. Got it. And then just one for Tom. Tom, kind of top level, just I'm seeing people write about things like some of these public utility oversight boards that a lot of the boards are kind of wanting to invest more in renewable. So they're investing in battery farms for renewables. It may be less so in a natural gas type utilities. Are you guys seeing that? Does it concern you at all long-term in terms of, you guys have talked a lot historically about the move from coal to natural gas and I'm just wondering about maybe what people's political views are that could kind of throw a wrench into that?

Yes, I think our opinion on that is that you'll see some batteries coming in to this battery storage support renewables. The economics so are very challenged on those. And I think it's going to be very much a niche and that you're going to definitely need to support the grid and power demand with natural gas. So we're still bullish on natural gas. We will see some of those come in. But unless there is a huge breakthrough in battery technology that we haven't seen, it's hard to see that really getting to be a large market. And also you have to look at the rest of the world where natural gas turbines or natural gas engines are really the right emission-friendly power generation at the right cost. They can't afford these other technologies.

Appreciate the color.

Welcome.

Thank you. And our next question comes from David Strauss of Barclays. Your line is open.

Thanks. So think on the Max, you talked about supporting the OEM rate but could you clarify, are you still at 52 or are you somewhere below 52 a month on the Max?

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

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

We're really close – we're at a 21 at the end of this quarter. So we anticipate being there or a little bit ahead of target.

Okay. All right. Thank you.

Thank you. And our next question comes from Gautam Khanna of Cowen and Co. Your line is open.

Hey, good afternoon, guys.

Hey, Gautam.

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

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

Yes. Above 42 presumably, the last quarter you were low 52 is that a fair assessment that I’m just trying to get the slope at it?

Yes, that’s correct. Yes.

Okay. And then the 42 that’s you're expecting for all of fiscal Q4?

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

And then just curious, how fluid is it with your customer, GE on this? Is that something were month to month, week to week you get changes in…

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

Okay. Bob, maybe for you, I am just curious, what are the add-backs this year? At one point, I thought we thought the purchase accounting stuff that would be excluded would equate to about $20 million, but I want to make sure we have the adjusted EPS add-backs correct in fiscal Q4 so what should we expect there?

The two main areas are Duarte to Drake transition. And so we call that out as well as the backlog. And you're pretty much right on with the backlog amortization. And then we anticipate that Duarte to Drake is largely complete. There may be some spillover into the fourth quarter, but we're pretty much out of the facility so most of those costs should be behind us. Same thing with the backlog on the amortization that's behind us as well so fourth quarter, hopefully we'll be fairly clean, in 2020 those items will be gone.

Okay. And then to follow-up in an earlier question, I think Sheila asked about the aftermarket. You mentioned, I think that there were some real-time slow down, anything you can generalize about where, why, what might be driving that and maybe some geography or product area or anything?

Yes. Let me clarify. It's not a slow down, repair and overhaul type work is actually strong. We had very tough comps from the year ago. So if we didn't meet the signal that it's down, actually the market is incredibly healthy. The one area that has slowed down for us is we had planned more initial provisioning tied to the Max and obviously that kind of ground to a halt until the aircraft is back into service. So those sales are not lost, they're delayed and we anticipate this, we will see those next year. But on the maintenance side, the MRO side, it's robust. And going forward, Commercial MRO looks strong going into next year as well, beyond the fleet dynamics as we've highlighted for awhile are very favorable to our company. The shop visits are going up. It's just that we have, as you could tell in the last couple years, we've had very strong performance here. So each year the comps are tougher, but it's a robust number and there's no slowing down that we're seeing at the moment.

Thank you. I appreciate it.

You're welcome.

Thank you. And our next question comes from Christopher Glynn of Oppenheimer. Your line is open.

Hey, thanks. Good afternoon. A question on the 737MAX, is there any impact to your cash flows or cash timing that impacted your initial free cash flow outlook that may be you're making up elsewhere?

Well, the one that we were anticipating is what highlighted in the initial provisioning sales, those are spare sales that airlines buy to support their new aircraft. Those carry a nice margin and those sales have primarily have dried up. So there was worry in our free cash flow projection, but at the same time our MRO was doing well. And as Bob highlighted, we see a working capital improvements happening in the fourth quarter and also slightly lower CapEx. So, combination of all that is how we're still holding onto the $300 million.

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

Yes. Well, a lot of our markets are cyclical, right now as we're looking at that. The fundamentals for L’Orange market are strong. What we anticipate being able to do is add some additional customers. We talked about that with L’Orange being part of Woodward, being an independent from any engine manufacturer. We are seeing a lot of customer interests. We're working on some new programs that'll start migrating into new revenue streams over the next couple of years cause these programs take awhile to develop. In the meantime, tougher emission regulations around the world are driving, for more complex, fuel injection systems, control systems that favors L’Orange. So we're seeing continued growth there. And then, there's a very nice aftermarket and as utilization goes up we're seeing higher utilization driving spare parts. So overall, we're seeing, L’Orange, probably in the low double-digits.

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

Great. Thank you.

[Operator Instructions] Our next question comes from Michael Ciarmoli of SunTrust. Your line is open.

Hey, good evening guys. Thanks for taking the questions.

Good evening.

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

Yes, on the first and reversed on the second part. So, we are a 100 basis points roughly down in the overall rate. And, for the – I’m sorry I just lost my train of thought, on the second part of the question.

Transition tax

Yes, the transition tax was actually a hit to us in the quarter. It's non-cash, there's an eight year period, so eventually there's cash related to it, but in the current quarter it's non-cash increased tax expense.

Got it. And just on the MAX, so just to, I guess calibrate our expectations. So as we go into next year, should we assume that, you're keeping that rate moderated at 42, because it would seem like it would be then a pretty decent headwind. I mean, I don’t know what your blended ratio might be for, or your annual deliveries for fiscal 2019, but assuming for planning purposes 42, I mean, that could be a $30 million to $40 million headwind potentially. Is that how we should be thinking about next year with that conservatism in mind?

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

Got it. No, I was just looking at your content, assuming, 290,000 and at 120 fewer units, that works out to about 35 million or so.

Right. That’s the math.

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

We're seeing pretty good trends. There's definitely variability in the aftermarket, especially if you go quarter-to-quarter, but the after market is really driven by utilization, still strong. With that, overall we see some pretty good spare outlet, spare parts outlook. So, right now that's going well. And there's multiple end-markets, as you know, L’Orange has a good presence in power particular data centers, very good presence in marine and we also have oil and gas. So you have to look at the dynamics in each of those markets, both from an OEM and an aftermarket and utilization standpoint. Marine utilization has been good. Oil and gas has been good. Data centers don't drive a whole lot of aftermarket good on the OEM side.

So got it. All right. Good stuff. Thanks guys.

Thank you.

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

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

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

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

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

Great. That’s all I had.

China's VI will start, China's VI engines and trucks will start gaining in 2020.

Okay, thanks.

Thank you. And our next question comes from Gautam Khanna of Cowen and Co. Your line is open.

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

Yes, we know exactly what it is.

Yes. So one of the things I was trying to square is, they've talked about – they general electric has talked about using, what part of the reasons they were capped at 52-ish a month was to catch up on provisioning spares.

Yes.

Because they were lagging the rate, the whole supply chain. So, I would actually think,

Yes, there is some difference on that Gautam. There's a little bit of difference for clarity. Spare initial provisioning engines, you want to say spare engine, we do not have as a spare to Woodward. What we get as spare hardware, Woodward are used to the airlines. Okay. So there's a little bit of difference, so you're hearing is an engine spare not a Woodward spare, if that makes sense to you.

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

Correct.

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

No, we do not.

Got it. So that's an OE sale. Okay, fair enough. That actually clarifies a lot. Thank you.

Okay, you're welcome.

Yep. Helpful.

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

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

Ladies and gentlemen, that concludes our conference call today. If you would like to listen to a rebroadcast of this conference, it will be available today at 7:30 PM Eastern daylight time by dialing 1855-859-2056 for U.S. call, or 1404-537-3406 for non-U.S. callers, and by entering the access code 4592857. A rebroadcast will be available at the Company's website, www.woodward.com, for 14 days. We thank you for your participation on today's conference call and ask that you please disconnect your lines. Everyone have a great day.