Woodward - Earnings Call - Q1 2020

Transcript

Speaker 0

Thank you for standing by. Welcome to the Woodward, Inc. First Quarter Fiscal Year twenty twenty Earnings Call. At this time, I would like to inform you that this call is being recorded for rebroadcast 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. Jack Thayer, Vice Chairman, Corporate Operations 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.

Speaker 1

Thank you, operator. We would like to welcome all of you to Woodward's first quarter fiscal year twenty twenty earnings call. In today's call, Tom will comment on our markets and related strategies as well as our planned merger with Hexcel Corporation. Jack will then discuss our financial results as outlined in our earnings release. At the end of our presentation, we will take questions.

For those who have not seen today's earnings release, you can find it on our website at woodward.com. We have 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 02/17/2020. 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. 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 US GAAP financial measures. We direct your attention to the reconciliations of non US 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. Turning to our results for the first quarter. Net sales for the 2020 were $720,000,000 compared to $653,000,000 for the prior year quarter, an increase of 10%. Net earnings were $53,000,000 or $0.83 per share compared to $49,000,000 or $0.77 per share for the prior year quarter. Adjusted net earnings were $71,000,000 or $1.1 per share, compared to adjusted net earnings of $62,000,000 or $0.96 per share for the prior year quarter.

Net cash generated from operating activities for fiscal twenty twenty was $27,000,000 compared to $85,000,000 for the prior year. Adjusted free cash flow was $29,000,000 Free cash flow was $53,000,000 for the first quarter twenty nineteen. Now I will turn the call over to Tom to comment further on our results, strategies and markets.

Speaker 2

Thank you, Don, and good afternoon, everyone. Woodward delivered a solid start to fiscal twenty twenty as seen in the first quarter's performance. Our Aerospace segment continued to deliver strong results. Our Industrial segment performed as anticipated with headwinds from softening oil and gas and associated aftermarket. Before turning to our markets, I would like to revisit the exciting news announced in January in which Woodward expects to combine with Hexcel Corporation in a merger of equals.

Coming together, we will create a powerful company to develop leading platforms and provide innovative solutions for our customers and significant value for our shareholders. Woodward Hexcel will build upon the legacies of these two industry leading companies to form a premier integrated system provider focused on developing technology rich innovations that deliver smarter, cleaner and safer solutions for our customers in the aerospace and industrial sectors. We believe the future of flight and energy efficiency will be defined by next generation platforms delivering lower cost of ownership, reduced emissions and enhanced safety, creating an exciting opportunity for Woodward Hexcel to be at the forefront of such a critical evolution. Financial benefits of the merger are compelling. For our respective fiscal twenty nineteen on a pro form a basis, Woodward Hexcel would have more than $5,300,000,000 of revenue and EBITDA margin of about 21%.

Woodward Hexcel will have a strong balance sheet with significant opportunities for enhanced revenue growth. We intend to deploy cash towards share repurchases, which includes executing on an expected $1,500,000,000 share repurchase program within eighteen months after closing. This would represent approximately 10% of the anticipated market cap of Woodward Hexcel. We also will have an initial dividend yield target of 1%. To align with this target, Woodward is increasing its current quarterly cash dividend to $0.28 per share effective with our dividend payment on March 3.

I am pleased in collaboration with my Hexcel counterpart, Nick Stanage, to bring these two teams together. Over the next several months, we will be hard at work to take the necessary steps to close this merger and prepare for a seamless integration of our companies. As a reminder, the transaction is expected to close in the third quarter of calendar year twenty twenty. Now moving to our markets, our Aerospace segment continues to be supported by a strong market. Commercial Aerospace continues to benefit from the strong flight utilization trends and sustained global passenger growth, which are driving increased Airbus narrow body production rates as well as robust aftermarket activities.

Despite uncertainty around the timing of the Boeing seven thirty seven MAX return to service, Woodward had improved initial provisioning in the first quarter. In defense, increased military budgets and spending drove further demand of Woodward platforms, including fixed wing aircraft, rotorcraft and guided weapons. Defense aftermarket remained strong due to global upgrade programs as well as The U. S. Initiative to improve combat readiness.

Strong commercial aftermarket and defense activity is helping us weather the delays related to the seven thirty seven MAX. Turning to our industrial markets, power generation, the industrial gas turbine market continues to stabilize as global power demand increases and domestic upgrade initiatives transition from planning to execution. We continue to expand our content on new turbine programs, which is increasing our market share and driving revenue growth. In addition, we determined our renewables business was no longer a key focus area for Woodward from the perspective of capital investment and resource allocation. We are streamlining our power generation business with today's announced divestiture of our renewable power systems and protective relay businesses to the Aurelius Group for $23,400,000 We expect this transition to close in our third quarter.

As a result of the divestiture, we estimate that industrial sales will be reduced by 45,000,000 to $50,000,000 and the related earnings impact will be approximately zero for fiscal twenty twenty. The divestiture will have a modest impact on twenty twenty margins and approximately 100 basis points of favorable impact on 2021 industrial margins.

Speaker 0

In transportation, China natural gas truck orders and revenue were strong for the quarter as production rates for China six compliant trucks recovered from the large pre buy of China five compliant trucks, which had negatively impacted sales in previous quarters.

Speaker 2

We anticipate the strong demand for natural gas trucks in China to continue as the Chinese government enforces emission regulations and incentivizes the use of natural gas instead of diesel and as China's access to natural gas improves. Oil and gas long term prospects are promising, driven by developing countries. However, the near term market is softening amid a slowing global economy, pricing volatility and decreased capital investments related to the reduced drilling activity, particularly within the North American market. In summary, while the overall aerospace market remains solid, the ongoing setbacks with the July MAX are expected to be partially offset by stronger aftermarket and defense. In industrial, strong China natural gas truck sales and recovering gas turbines are offsetting softness in oil and gas.

As we look to the remainder of the year, we look forward to the opportunities created by the expected combination of Woodward and Hexcel, while remaining focused on our operational performance and delivering superior shareholder value. Now let me turn it over to Jack to discuss the financials.

Speaker 3

Thank you, Tom. Aerospace segment net sales for the 2020 were $474,000,000 compared to $393,000,000 for the first quarter a year ago, a 21% increase. The increase in commercial OEM was primarily driven by higher narrow body production rates compared to the prior year quarter. Commercial aftermarket sales were up 14% in the 2020 as compared to the prior year quarter. Despite uncertainty surrounding the seven thirty seven MAX, initial provisioning in the quarter was higher than the prior year quarter, and we continue to see strong aftermarket on legacy platforms.

For our second quarter of twenty twenty, we anticipate a decline in initial provisioning compared to the prior year quarter as a result of the MAX grounding. Defense OEM sales growth in the quarter was driven by smart weapons and fixed wing aircraft, while defense aftermarket activity was robust as a result of increased military spending and upgrade programs. Aerospace segment earnings for the 2020 were $93,000,000 or 19.6% of segment sales compared to $73,000,000 or 18.5% of segment sales for the first quarter of twenty nineteen. Segment earnings were primarily impacted by the higher sales volumes. Turning to Industrial.

Industrial segment net sales for the 2020 were $246,000,000 compared to $260,000,000 in the prior year period, a decrease of 5%. In the face of a very strong comparable period in the prior year quarter, Industrial segment sales declined primarily as a result of expected softness in oil and gas, which resulted in reduced aftermarket activity and in inventory management. The sales decline was partially offset by improved sales in our Renewables business. Industrial segment earnings and adjusted Industrial segment earnings for the 2020 were $28,000,000 or 11.5% of segment sales. Industrial segment earnings were $29,000,000 or 11.2% of segment sales for the first quarter of twenty nineteen.

Adjusted Industrial segment earnings for the 2019 were $39,000,000 or 14.9% of segment sales. The decline in adjusted Industrial segment earnings was mainly due to softer sales volumes in the quarter, largely due to lower oil and gas aftermarket. At the Woodward level, non segment expenses were $51,000,000 for the 2020 compared to $29,000,000 for the same period of the prior year. Adjusted non segment expenses for the 2020 were $27,000,000 compared to $22,000,000 for the same quarter last year. R and D spending for the 2020 was 5% of sales compared to 6% for the prior year quarter.

The effective tax rate for the 2020 was 13.3% compared to 20.1% in the first quarter of twenty nineteen. The adjusted effective tax rate was 17.1% for the quarter compared to 21% for the first quarter of twenty nineteen. During the quarter, one of two parcels of the real property at our former Duarte Operations was sold for $19,000,000 which resulted in an after tax gain of $10,000,000 or $0.16 per share. We anticipate the other parcel to be sold by the end of the third quarter of fiscal twenty twenty. Also during the quarter, in conjunction with our decision to divest our renewable power systems portfolio, predominantly related to the announced sale of the RPS and Protective Relays businesses to the Aurelius Group, we realized an impairment charge on the associated assets held for sale, which resulted in a non cash after tax charge of $28,000,000 or $0.43 per share.

Adjusted net earnings excludes the impact of the gain on the sale of the Duarte real property and the financial impacts of the sale of the renewables portfolio. The pretax amounts of both items are reflected in non segment results. Looking at cash flows. Net cash generated by operating activities for the first quarter was $27,000,000 compared to $85,000,000 for the prior year quarter. Capital expenditures were $17,000,000 for the first quarter compared to $31,000,000 for the prior year quarter.

Free cash flow for the 2020 was $10,000,000 compared to free cash flow of $53,000,000 for the first quarter of twenty nineteen. Adjusted free cash flow for the first quarter was $29,000,000 which includes the 19,000,000 of proceeds from the sale of the first parcel of the Duarte Real property. The decrease in cash flow was the result of higher working capital. Lastly, turning to our fiscal twenty twenty outlook. As we look ahead at the remainder of fiscal twenty twenty, our previously stated outlook has been updated to reflect the impacts of the $7.37 MAX, weaker oil and gas sales, the sale of the renewables portfolio, the lower tax rate and higher outstanding share count.

Any potential impact from the coronavirus is unknown at this time and therefore not reflected in our outlook. Total net sales are now expected to be between 2,900,000,000.0 and $3,000,000,000 Aerospace sales are anticipated to be up low single digits compared to the prior year. We assume a return to service of the seven thirty seven MAX in mid-twenty twenty, and our build rates are in line with our customers' schedules. Aerospace segment earnings as a percent of net sales are expected to be approximately 21%. Taking into account the impacts of weaker oil and gas sales and the sale of the renewables portfolio, industrial sales are now expected to be approximately flat compared to the prior year.

Industrial segment earnings as a percent of segment net sales are expected to be approximately 14%, which reflects the benefit from the sale of the renewables portfolio being offset by weaker than anticipated oil and gas sales for the full year. For Industrial, we anticipate first half softness to be offset by improved results in the second half of the fiscal year. The adjusted effective tax rate for the year is expected to be approximately 20%. Adjusted earnings per share, which excludes the impacts of the gain on the sale of the Duarte Real property and the impairment charge related to the renewable power systems portfolio, is now expected to be between $5.22 and $5.52 based on approximately 65,000,000 of fully diluted weighted average shares outstanding. The increase in share count from 64,000,000 to 65,000,000 has a negative impact of approximately $08 for the fiscal year.

As

Speaker 2

a result of

Speaker 3

the merger agreement with Hexcel, we will not be repurchasing as many shares in the fiscal year as originally planned in our outlook for fiscal twenty twenty. However, within the eighteen months following the close of the merger, we anticipate repurchasing approximately $1,500,000,000 of Woodward Hexcel stock or approximately 10% of the anticipated market capitalization of the combined entity. Please refer to slide 13 for a bridge of earnings per share from our previous outlook to our current outlook for adjusted earnings per share. For 2020, we anticipate adjusted free cash flow to be approximately $420,000,000 This concludes our comments on the business and results for the first quarter of fiscal year twenty twenty. Operator, we're now ready to open the call to questions.

Speaker 0

Thank you. The question and answer session will begin at this time. If you are using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press star one on your push button phone. Should you wish to withdraw your question, Your question will be taken in the order it is received.

Please stand by for your first question, sir. Our first question comes from Robert Spingarn.

Speaker 2

Hi, good afternoon. Hi, Ro.

Speaker 4

So a couple of things. I think, obviously, top of mind for a lot of people from the merger perspective, Tom, is this billion dollar target. And the the the fact that it didn't really reconcile with what consensus was for the two companies together. We've all talked about this since then. Is there any more color that you can add on how the two companies get there beyond the synergies since the gap is closer to about $2.50 to 300,000,000?

Speaker 2

Not really at this time, Rob. You know, we aren't providing any new updates. You know, what I would say is it's the first full year after closing and, you know, we're both making progress and improvements on free cash flow. So there's been no change to our commentary on that.

Speaker 4

Okay, and then with regard to the guidance on free cash this year, maybe this question for Jack, but it does include, if we understood this correctly, the proceeds from some dispositions, I guess this was in Duarte?

Speaker 3

That's correct. Sorry, go ahead.

Speaker 4

Well, was just going to ask you if any further dispositions are contemplated in that long term guide for the combined company?

Speaker 3

So Rob, as you'll recall, we at the guidance for fiscal year twenty twenty, we had announced a target of $400,000,000 of free cash flow. We're taking that up with the disposition of our Duarte facility, the first parcel of that to $420,000,000 That, was effectively $19,000,000 of proceeds. We would anticipate a further $13,000,000 of proceeds, when the second parcel closes in Q3.

Speaker 4

Okay. But there's nothing foundational about dispositions in the $1,000,000,000 target?

Speaker 2

No. Okay.

Speaker 4

And then just, as last question, what is the continence for you as well, Jack? You talked about a backend weighted industrial, year, some improvement in the backend. What gives you the confidence that the markets are going to evolve that way?

Speaker 2

Well, yeah, I'll pick it up first and Jack can add to it. The first thing would be, our order book, which is more backend weighted this year. Recovery we're seeing in the gas turbine market and the rest of the turbo machinery market, those are longer lead programs. So we've got some good insight that those are covering. Second half on, China natural gas and natural gas truck sales are higher.

And so that outlook is in our forecast and, you know, some of that's transitioning into the order book. So that's what gives us a little more confidence in the second half of the year.

Speaker 4

Thank you, Tom. Jack.

Speaker 5

Your

Speaker 0

next question comes from Tom Kahana.

Speaker 6

Hi, thanks. Just following up on Rod's question. So if we take the $420,000,000 of adjusted free cash flow this year and strip out dispositions, so you're slightly under 400,000,000 right? And then, we take Hexcel's guide of $300,000,000 plus, we're at 700. And I'm just wondering, is there something that the street is just not understanding that CapEx comes way down in 'twenty one or is there some sort of kind of catch up or is this just, the streets are mis modeling earnings, you guys are going to just come in, you think you have a better fiscal twenty twenty one untapped than what right now is understood.

Speaker 2

Yeah, so it's, you know, again, it's basically the same commentary we've given before, but it's increased earnings, lower CapEx, synergy savings, all coming together. And, you know, that is our intent and on top of that, you know, we're anticipating improved working capital.

Speaker 6

Okay, there's nothing on tax rates or, you know, something else that? No. That you can point to? No. Okay.

And what's the CapEx guide implied in the fiscal twenty numbers right now?

Speaker 3

$80,000,000

Speaker 6

Okay. Yeah. Because that alone could not explain even if it dropped dramatically. Okay, and then just on the aftermarket, commercial aerospace aftermarket in the quarter itself, what was the growth rate? And could you, maybe parse out how much you think owed to initial provisioning that doesn't occur as we move through?

Speaker 2

Well, what we had, we had a strong quarter is up 14% on commercial aftermarket. We did have strong initial provisioning in the quarter. I believe some of that was utilization of capital budgets, by some of our customers at the end of the year. Looking forward, we're being cautious on initial provisioning related to max sales, obviously, it's a big program, until we really, lock down return to service, the rate of return to service, we think, some of that will push to the latter part of the year or into next year. Downgoing, MRO is strong, on commercial, but we're also seeing very healthy defense aftermarket.

So overall, are positives that continue, as we look forward through the rest of this year.

Speaker 6

Any sense for how much of the 14% growth in the quarter owed to initial provisioning? Was it a third or is there any sort of qualification you can give?

Speaker 2

No, I don't have any at this time. Was a good initial provision, but it was very strong legacy MRO as well.

Speaker 6

Okay, and then just, as you move through the year, what is your overall expected aftermarket growth, commercial aero aftermarket growth?

Speaker 2

Yeah, look, yeah. Yeah, go ahead. Go ahead.

Speaker 6

Go ahead. And then the last one, I know you mentioned it's fluid with, your customers on the MAX. Do you actually have firm schedules right now? Have they conveyed what rate you should go to and when you should step it up and what have you? Or is that

Speaker 5

still Yeah, a so,

Speaker 2

okay, I'll answer, I'll get to both questions. First is, we're projecting mid single digits for commercial aftermarket for the full year. Part of that is we had really strong comps that we're going to be comparing against. The second question you had, we do have from our customers, so from Boeing and we have a wide range of tier one customers that we support on the MAX. We have, gotten various production rates, they're not all the same just due to each individual, if you wanna say the tier ones have their own rates that they're looking at.

Our outlook reflects those rates and we think it reflects what Boeing's planning to do. And so we think that outlook is properly, considered in our full year.

Speaker 6

Okay, but just to be clear, do you have some percentage of customers that have not conveyed?

Speaker 2

No,

Speaker 6

You've got it. Okay.

Speaker 2

We've got it.

Speaker 6

All right. Okay. Thank you very much. I appreciate You

Speaker 3

bet.

Speaker 0

Your next question comes from the line of David Strauss.

Speaker 7

Thanks. Good afternoon.

Speaker 2

Good afternoon. So

Speaker 7

going back on the MAX, looks like rough math, you've taken out maybe 300 shipsets this year, maybe down closer to in line with what Hexcel was talking about around 200, is that correct?

Speaker 2

Yeah, I just like to highlight that, you know, the rate varies between Boeing and some of the tier ones, it's pretty consistent, but that's not way off. You know, we have, I'm hesitant to share production rates since Boeing did not put out formal guidance on their production, but we're in line with their plans.

Speaker 7

Okay. And Tom, would you anticipate halting or you think you just go to a lower rate? What rate are you at right now? Are you still at 42 or have you already come down?

Speaker 2

No, it's down from that and, we have not halted, but it's come down in line with the expected rates that Boeing and others are asking us to go to. So, if the shutdown continues longer, that could have an impact on us. But right now, we're following the guidance that we've been given by Boeing and our tier ones and that's what we're running to. Okay. As you know, it's a significant drop.

Speaker 7

Yep, and then in the bridge, have a box that's cost containment. Can you

Speaker 8

talk about

Speaker 7

what's entailed in that? What you're looking to do to offset the impact? Is it labor? Is it taking your own suppliers down or?

Speaker 2

Yeah, so sure. There's quite a few things in there. There's definitely some labor elements from adjusting. Let me back up on labor for first thing. We have a highly skilled workforce, so we're being cautious on maintaining that workforce.

We do regularly have contract and temporary labor that supports, you know, surges and production and variation from month to month, quarter to quarter. So we've adjusted that contract temporary labor, we've, dramatically taken down overtime that we were running. We've redeployed, skilled labor into, other parts of our business, to preserve that skilled labor. We've gone after all discretionary expenses, discretionary spending, and we're attacking productivity and, we are working hand in hand with our supply base to also have them, be able to handle the temporary downturn and then the recovery and the ramp. So it's a challenging environment because you know, you're gonna go down, but then you're gonna come back up and the type product we make, does require very skilled labor and a lot of, special machinery that and specialty activity from our supply base that we need to retain.

So we're working hard to do that, but we, you know, as we saw this coming, we were very aggressive on our cost actions. So that's how we're recovering some of that back.

Speaker 7

Okay, thanks very much.

Speaker 2

You're welcome.

Speaker 0

Your next question comes from Sheila Kahyaoglu.

Speaker 9

Hi, good afternoon everyone and thank you for the time. Hey, I wanted to ask about free cash flows, but following up on some of the ones that are asked already. Just two questions, I guess Jack, why raise it so early given the volatility with the MAX that we might have as well as oil and gas? And a follow-up to that, Tom, just given we've had a chance to digest the deal, looking at Woodward's inventory and payables, working capital turns are actually quite good relative to commercial suppliers. So how do we think about that working capital opportunity longer term?

Speaker 3

Okay. Sure, Sheila. I'll start. So as you might expect, we had some measure of visibility into the MAX with respect to the delay in returning to service. And so as we're building our forecast for the year, factoring that as well as what we saw as initial insight into oil and gas softness in the industrial side, we believed our $400,000,000 forecast was very achievable.

And so with the actions that we began taking that Tom referenced earlier around cost containment, some of the puts and takes with respect to the strong aftermarket, and defense, OEM and aftermarket sales that we've seen, we felt we had a good anchor at $400,000,000 We've taken that up just to reflect really the benefit of the sale of the Duarte parcel, and, we feel we have a good degree of visibility and levers under our control to hit that four twenty or better number.

Speaker 2

Yeah. And then second half of your question, Sheila, the place to really look is we do manage, receivables very well, but the place to look is around inventory. And our inventory is higher than, what we would normally expect. We think there's just, performance improvement there operationally. But second as a reminder, we still ramped up a lot of inventory for some of the facility moves, ramping up for the launches of the narrow body programs.

And so we see a sizable reduction in our inventory over the next couple of years.

Speaker 9

Is there a benchmark that you have terms of how we should look at it in days outstanding or percentage of sales?

Speaker 2

Yeah, if you look at inventory, we're in the 20 percentages points of inventory and I really see that getting down fifteen, sixteen.

Speaker 9

Okay, and then I had a follow-up on the MAX. Given you did have initial provisioning associated with it and aerospace profitability was better, how do we think about the decrementals associated with that business? Is the OE loss making? Is it breakeven, coupled with the aftermarket?

Speaker 2

Yeah, you know what I would say, you know, we're very proud of at the company is, we don't lose money on OE sales. Okay, so sometimes I think people have a perspective that that's, the case. There is obviously a wide margin difference between aftermarket and OE, but we're not losing money on OE sales. So, as you look at that. So when we factor it in, we still have strong OEM sales across the board.

Our aftermarket strong, defense has been strong. So you take, defense aftermarket is strong. So when you add all those up, you get a very strong margin mix and we're highly confident in maintaining our 21% guidance for the year.

Speaker 9

Okay, thank you.

Speaker 0

Your next question comes from Christopher Glenn.

Speaker 5

Thank you. Good afternoon. Hey, on the aerospace outlook obviously implies down revenue Q2 to Q4 is a three quarter chunk. Just wondering if you could help us, picture how that phases in. Do you have it coming back in the fourth quarter, for instance, and kind of absorbing all the negative variance in the next couple of quarters?

Or what's kind of a way to think about that?

Speaker 3

Chris, I'd say that the balance of the three quarters is flat. You will see some commercial aftermarket softness in Q2. As we referenced earlier, we had really strong IP sales in the second quarter of fiscal year twenty nineteen. We would not expect that to repeat in, second quarter of fiscal year twenty twenty. But generally speaking, aerospace is flat the following three quarters.

Speaker 5

Okay, thank you for that. And, just in terms of the defense markets, looks like they may took another step up. How would you describe the kind of continuity in the ramp in those markets if we get a little more granularity around that?

Speaker 3

So from a year over year perspective, I think you'll see, you saw a strong Q1. We would anticipate, not quite as strong, but relatively strong Q2 with tempering of year over year performance in the back end of the year to roughly flat.

Speaker 5

Flat kind of exiting the year?

Speaker 3

Correct, in Q3 and Q4. We had strong performances in Q3 and Q4 of last year. We'd expect to roughly repeat those this year.

Speaker 5

Okay. And just wanted to lastly check-in on the, L'Orange performance.

Speaker 3

I think as we, spoke to with respect to our the entirety of our diesel fuel systems business, we did, have anticipated softness in the quarter. We would expect that to continue in Q2 with materially improved volumes in Q3 and Q4 of fiscal 2020.

Speaker 5

Great. Thanks a lot.

Speaker 0

Your next question comes from Christopher Howe.

Speaker 10

Good afternoon. Good start to the year.

Speaker 3

Thanks.

Speaker 10

Few questions here remaining. I guess just for clarification purposes, if we were to strip out your expectations for the MAX in the remainder of the year or for the year entirely, how would this year compare to last on an aggregate basis and on a commercial aftermarket basis?

Speaker 2

You mean year over year without MAX, is that what you're

Speaker 10

talking On a pro form a basis, just trying to understand underlying strength within aftermarket and then as Yeah. A

Speaker 2

Yeah, it's still strong. Guess I don't have that calculation in front of me, but even we max aftermarket really hasn't, I mean, we had a nice initial provisioning, but, year over year, biggest the driver is legacy programs and the strong legacy aftermarket. Okay.

Speaker 10

And then another question just on the industrial segment, you guided to 14%. Whether it's this year or beyond, how should we look at the different puts and takes that would lead to margin expansion within Industrial?

Speaker 2

Yes. Well, one, as we highlighted, the removal of the renewable portfolio, from industrial is about 100 basis points. And then volume increases which, we're coming off some, we're coming off some lows that were in the turbomachinery market that's coming back. And then overall, we are also seeing productivity. Combination of those is how we get to sixteen, sixteen plus.

Speaker 10

Okay, great. That's all the questions I have for right now.

Speaker 6

Appreciate it. Thank you.

Speaker 2

Chris.

Speaker 0

Next question comes from Pete Skibitski.

Speaker 8

Good afternoon, guys. Hey, Tom, how did the short cycle businesses perform in industrial in the first quarter? Just I think people are still nervous about the global macro and the coronavirus. And I wasn't sure if you guys comments earlier about lorange and diesel was proxy for all that or not.

Speaker 2

Well, L'Orange is usually tied to more longer cycle industrial and maybe just a little more clarity, you know, on L'Orange, the L'Orange as a total business is still doing quite well. We saw over the last, you know, eighteen months to twenty four months, there was a resurgence in the, if you wanna say the fracking market and we saw a lot of rigs needed to be rebuilt, inventory needed to be replenished and we saw a really strong oil and gas sales both new, but also in the aftermarket and that really benefited LaRange. As we moved into, for our first quarter here, we were anticipating, but we did see some softness tied also to oil prices and the, point at which it's attractive to drill. And so, we'd call it like a pullback, but pullback is that the, reduced drill count, the inventory had been replenished in the distribution channels and so we saw those slowness there. Overall, L'Orange is still doing strong, we're very happy with it, integrating, but we did see a reduction in sales tied to that market, to L'Orange.

Okay. So that would be, that's our longer cycle. Shorter cycle is when you get into some of the activity around our small engine business, the, natural gas activity in China, tied to the, on highway truck business. As we highlighted, we saw, early on during the quarter, some of the pre buy effects, if you recall from going from China five to China six emission standards, we started seeing recovery in that. Going forward here, we have a very positive outlook for China six emission compliant engines.

That's our short, that's one of the shorter cycle businesses we have. That we, every trend is in the right direction except for the Corona virus. And we really don't know how to forecast or predict what's gonna happen there. So, short cycle is down a little bit due to those factors, but we'll start recovering subject to that, that doesn't become a major issue.

Speaker 8

Okay. And then just to clarify, the L'Orange Marine aftermarket, you guys have talked about that a lot. Is that still how is that doing?

Speaker 2

Still doing well.

Speaker 8

Okay. Okay. Last question for me. I just can you give me a sense of the noncash revenue, how that impacted this quarter in aerospace? You guys have started to disclose that in your 10 Qs, I guess, post ASC six zero six.

I just wonder if that impacted the growth here in the first quarter or if it was truly all the IP?

Speaker 2

No, it was that was basically flat.

Speaker 8

Okay. Okay.

Speaker 2

Thanks, guys. Okay. You bet.

Speaker 0

As a reminder, should you have a question, please press star one on your push button phone. Once again, Your next question comes from the line of Michael Carmoli.

Speaker 11

Hey, good evening, guys. Thanks for taking my questions here. Maybe just on in light of kind of the cadence for the year in Aerospace with the flattish revenue run rate, how should we be thinking about the margins expanding? Is that going to be from the cost containment measures? I mean, presumably, you're going to have some excess capacity there.

But what gives you the confidence in that margin expansion? And I know the Aerospace growth rate will be down on tougher comps, but maybe not down in absolute dollars obviously, but how do we get comfortable with margins expanding on flattish volume from here?

Speaker 2

Yes. Well, first, there is the cost containments that I described earlier, but we also have had ongoing productivity improvements, around the major new programs as well as, using full capacity of our capital and the facilities we built. And those are coming together and we're seeing margin improvement even with the downside of the max across the board on all our other programs in our portfolio. So, yeah, so it's positive that way and then, we're also, I said, continuing to see good aftermarket, so that plays into it.

Speaker 11

Okay, and that's clearly offsetting the excess capacity from pulling out the 300 give or take unit to the max?

Speaker 2

That's correct. Some of, know, when I talked about redeploying, some of our skilled labor, some of that redeployment is going into our aftermarket activities.

Speaker 5

Okay.

Speaker 2

Better serve that. So,

Speaker 8

Got it. Okay. Okay. And then just back

Speaker 11

to the on the free cash flow for year one post closing, can you give us a sense, I mean, we sort of have a vague road map here of where the seven thirty seven rates might go. But I mean, do you need rates or was that target predicated on something north of 52 or 57? Or does that number become a little bit more challenged if production rates are only in the low to mid-40s? And then how does that contemplate I mean, we're going to see a fairly extensive cut here on the July going down to 10. So does that $1,000,000,000 become a little bit more challenged you know, maybe where that rate is and where the July is going?

Speaker 2

Well, you know, there's no doubt rate cuts, you know, put some stress on those numbers, but, we're committed to delivering those and we're going to get it through like you said that roadmap of activities. And we will be anticipating stronger sales throughout the rest of the portfolio as we go into 2021 and on to 2022, 2022 and continued productivity, working capital improvements and synergy savings. So yes, when you got a production cut that puts some extra stress, but overall, we think we'll be able to handle that and continue to drive to those numbers.

Speaker 11

Is low 40s or mid 40s at a production rate for the three seven, is that, I mean, would you articulate what you guys have built into that billion dollars on a rate?

Speaker 2

Yeah, we had an estimate, you know, when we released, since then, the supply chain, you know, Boeing and the tier ones have gotten a new indication of rates. Those differences are very small between what we had and what those newest estimates are coming from our customers. So I don't think there's a dramatic difference from what we had.

Speaker 11

Okay, perfect. Thanks guys, appreciate it.

Speaker 2

Okay, you're welcome.

Speaker 0

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

Speaker 2

Thank you. And I appreciate everybody joining us today. Thank you for your questions and I'll look forward to seeing many of you, throughout this next quarter. Thanks again. Goodbye.

Speaker 0

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