Woodward - Earnings Call - Q1 2021
February 1, 2021
Transcript
Speaker 0
Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Woodward Incorporated First Quarter Fiscal Year twenty twenty one 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 mister Tom Gendron, chairman and chief executive officer, mister Bob Webber, 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.
Speaker 1
Thank you, operator. We would like to welcome all of you to Woodward's first quarter fiscal year twenty twenty one earnings call. In today's call, Tom will comment on our markets and related strategies, and 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 02/15/2021. The phone number for the audio replay is on the press release announcing this call as well as on our website and will be repeated by the operator at the end of the call. I would like to refer to and highlight our cautionary statement as shown on Slide three. As always, elements of this presentation are forward looking or based on our current outlook and assumptions for the global economy and our businesses more specifically, including the ongoing COVID nineteen pandemic.
Those elements can and do frequently change. Please consider our comments in light of the risks and uncertainties surrounding those elements, including the risks we identify in our filings. In addition, Woodward is providing certain non U. S. GAAP financial measures.
We direct your attention to the reconciliations of non U. S. GAAP financial measures, which are included in today's slide presentation and our earnings release and related schedules. We believe this additional information financial information will help in understanding our results. Now turning to our results for the first quarter.
Net sales for the 2021 were $538,000,000 compared to $720,000,000 for the prior year quarter, a decrease of 25%. Net earnings and adjusted net earnings for the 2021 were both $42,000,000 or $0.64 per share. For the first quarter of fiscal twenty twenty, net earnings were $53,000,000 or $0.83 per share and adjusted net earnings were $71,000,000 or $1.1 per share. Net cash provided by operating activities for the 2021 was $147,000,000 compared to $27,000,000 for the prior year quarter. For the first quarter of twenty twenty one, free cash flow and adjusted free cash flow were both $139,000,000 For the first quarter of twenty twenty, free cash flow was $10,000,000 and adjusted free cash flow was $29,000,000 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. The negative impact of COVID-nineteen continues to weigh heavily on the world's economy with resurgences and new viral variants contributing to significant uncertainty. While the 2021 showed signs of stabilization in many of our markets across the globe, we still anticipate quarterly volatility related to the pandemic. Importantly, we took swift action at the beginning of the pandemic to prioritize cash management and a lean operational structure. As a result of these actions, our balance sheet and cash flow have remained strong.
And as we announced today, we have restored the first quarter dividend to the same level as the first quarter last year. We continue to closely monitor the situation and strategically adjust our business to align with customer expectations, while maintaining our strong financial position and continuing to invest for the future. Moving to our markets. Aerospace continued to be challenged with commercial OEM and aftermarket seeing the most substantial declines year over year. We're anticipating future improvements in passenger traffic with the rollout of vaccines across the globe.
Additionally, the Boeing seven thirty seven MAX is returning to service in many key markets with production rates expected to improve in '21. Defense OEM spending remains solid across fixed wing and rotorcraft applications. However, we continue to anticipate a softening of guided weapons production volumes. Defense aftermarket activity remains strong due to improved U. S.
Fleet readiness initiatives as well as global upgrade programs. Turning to our industrial market segments. In power generation, given the already depressed gas turbine market, low inventory levels and pent up demand for repair and overhaul, we do not expect this market to be as negatively impacted by the pandemic. Increased emissions regulations continue to drive the shift to natural gas powered and cleaner burning diesel engines. We also foresee continued growth in global energy demand moving forward, with the bulk of this expansion coming from Asia's developing economies.
In transportation, China natural gas truck demand was strong, though we anticipate seasonal pressure due to high demand for natural gas during the winter months. The global marine market continues to be severely impacted by the pandemic. The oil and gas market remains weak globally due to lower oil prices and lack of investment, although rig counts are showing some signs of improvement in recent weeks. In summary, our markets are stabilizing. We are beginning to see the payoff of our aggressive actions to address the challenges of COVID nineteen.
We are consistently engaging with our business partners to assess near term market demand and capitalize upon emerging opportunities. While we'll still see a significant amount of uncertainty and volatility in our markets, we do anticipate improvement as we progress through the fiscal year. We remain focused on operational excellence, delivering value to our shareholders and positioning Woodward to capitalize upon future market opportunities as they emerge. Now I'd like to turn the call over to Bob to discuss our financials in detail.
Speaker 3
Thank you, Tom. Aerospace segment sales for the 2021 were $322,000,000 a decrease of 32% from the prior year quarter. Commercial OEM and aftermarket sales remain weak as a result of the pandemic. Commercial aftermarket sales were down 47% in the 2021 compared to the prior year as a result of depressed passenger traffic. On a bright note, sequentially commercial OEM was up 13% driven by increasing demand for narrow body systems.
Defense OEM was down slightly in the quarter compared to a strong first quarter of the prior year, primarily due to lower sales of guided weapons, partially offset by higher sales in both fixed wing and rotorcraft. Defense aftermarket sales were flat compared to the prior year quarter, although activity remained solid. Overall, defense sales in the quarter were negatively impacted by COVID related absenteeism and supplier disruptions. Our defense backlog remains strong and we anticipate defense spending to continue at healthy levels. Aerospace segment earnings for the 2021 were $46,000,000 or 14.4 percent of segment sales compared to $93,000,000 or 19.6% of segment sales for the first quarter of twenty twenty.
The decline in segment earnings compared to the prior year was a result of lower volume, partially offset by cost reduction initiatives. Sequentially, the margin decrease from the 2020 was primarily due to lower defense aftermarket sales as well as the timing of spending on R and D programs. Turning to Industrial. Industrial segment sales for the 2021 were $216,000,000 compared to $246,000,000 in the prior year period, a decrease of 12%. Excluding the renewable power systems and related businesses, which were divested on 04/30/2020, and I will refer to as RPS, Industrial segment sales for the 2020 were $218,000,000 Decrease in industrial sales was primarily due to the RPS divestiture, the weak oil and gas market and ongoing impacts of the pandemic, partially offset by strong demand in the current quarter for China natural gas trucks.
Foreign currency exchange rates positively impacted Industrial segment sales by approximately $9,000,000 for the quarter. Industrial segment earnings for the 2021 were $33,000,000 or 15.2% of segment sales compared to $28,000,000 or 11.5% of segment sales in the prior year. Industrial segment earnings increased primarily as a result of cost reduction initiatives. Excluding RPS, Industrial segment earnings for the 2020 were $26,000,000 or 11.9% of segment net sales. Non segment expenses and adjusted non segment expenses were 23,000,000 for the 2021 compared to non segment expenses of $51,000,000 and adjusted non segment expenses of $27,000,000 for the same period last year.
Non segment expenses for the 2021 were favorably impacted by cost reduction initiatives. At the Woodward level, R and D for the 2021 was $32,000,000 or 6% of sales compared to $37,000,000 or 5.1% of sales for the prior year quarter. SG and A for the 2021 was $56,000,000 compared to $62,000,000 for the prior year quarter. The declines in both R and D and SG and A reflect our cost management actions taken in response to the pandemic. The effective tax rate and the adjusted effective tax rate were both 12.6% for the first quarter of twenty twenty one.
For the first quarter of twenty twenty, the effective tax rate was 13.3% and the adjusted effective tax rate was 17.1%. Looking at cash flows. Net cash provided by operating activities for the first three months of fiscal year 2021 was $147,000,000 compared to $27,000,000 for the prior year period. Capital expenditures were $7,000,000 for the 2021 compared to $17,000,000 for the prior year quarter. Free cash flow and adjusted free cash flow for 2021 were both $139,000,000 compared to free cash flow of $10,000,000 and adjusted free cash flow of $29,000,000 for the prior year period.
The decrease excuse me, the increase in free cash flow and adjusted free cash flow was primarily related to aggressive cost control, effective working capital management and lower capital expenditures. We are paying down debt and reduced have reduced our leverage to 1.7 times EBITDA at the end of the first quarter from two point zero times EBITDA at the end of the prior year quarter. We have significant liquidity available through approximately $1,200,000,000 of combined cash on hand and revolver capacity, which allows us to invest in new programs and other future growth opportunities, which will contribute to increased shareholder value. Importantly, we increased this quarter's dividend to pre COVID levels, underscoring our confidence in Woodward's financial position. While the sales volume declines we are seeing are significant, the aggressive actions we took at the beginning of the pandemic to prioritize cash management and a lean operational structure are having a positive impact on our performance.
Lastly, turning to our fiscal twenty twenty one outlook. The dynamic and volatile nature of the COVID-nineteen global pandemic has continued to cause uncertainty in many of our markets. While the ongoing rollout of vaccines across the globe has begun, new viral variants and regional resurgences make forecasting the future of our business challenging in the near term. Given this uncertainty and the protracted nature of this crisis, we will not be providing financial guidance at this time. Although we are optimistic that ongoing stabilization will lead to recovery across the globe.
This concludes our comments on the business and results for the first quarter of twenty twenty one. And operator, we are 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 then one on your push button phone. Should you wish to withdraw your question, press the pound key.
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 from Credit Suisse. Please state your question.
Speaker 4
Good afternoon.
Speaker 2
Good afternoon. Hi, Rob.
Speaker 5
You just Bob, I think you talked about the sequential increase in commercial I guess, from quarter to quarter here. When should we start to see that A320 rate hike factor in when we start drawing that through? And where are you on max rate?
Speaker 3
Maybe, Tom, I'll let you go ahead and comment
Speaker 2
on I'll I'll I'll say, you know, on the the a three twenty, we're we're tracking, you know, with the Airbus production schedule, as it flows back, you know, through from from Airbus for the direct sales to them and also through the engine OEMs. So we're right on the line with what they're doing. You know, we always, are maybe a couple months ahead of those rates. On the MAX, it it's a little it's a little hard to say in that there's a lot of inventory in the system, and, we're following Boeing's guidance to the supply base on how to prepare for the ramp up. But, you that'll be something we'll be watching very closely.
We're well prepared to meet the ramp as they move forward, but I don't think I can comment much more on what rate they're at today.
Speaker 5
Okay. And then just on the aftermarket side, we've started hearing some of the airlines talking about loading up for heavy maintenance just because so little has been done over the past year. Are you starting to see any corresponding evidence of an increase in engine inductions for shop visits coming up here during 2021?
Speaker 2
Rob, we're seeing forecasts and discussion with our customer that it's going to ramp up. But we did our first fiscal quarter was still a soft commercial aftermarket quarter, where we were sequentially down. But the forecast looks positive. And as we've highlighted in previous calls, the aftermarket definitely will be the first to recover. And we do anticipate as we move into the second half of our fiscal year that we're gonna start seeing aftermarket recover.
Speaker 5
Okay. And just the last one on the 777X schedule change. Know, how does that affect you? You know, I imagine you're on the engines, but possibly also, elsewhere on the aircraft. Are you involved at all in the actuation side?
And is there anything you could tell us about what's happening with that airplane in terms of actuation issues?
Speaker 2
Yeah. I I'm not aware of any actuation issues, so I can't comment on that. But, you know, we're we're on the aircraft, both on the direct to Boeing, but also on the GE nine x to GE. We're in good shape in terms of certification and having the hardware ready. And, you know, we're just working with the customers on, you know, the extended, entry into service time line.
But from a Woodward standpoint, we're in we're in quite good shape on that program. And There's no know, we're just
Speaker 5
No significant incremental cost for you from this push to the ride or anything like that?
Speaker 2
Not significant, Rob. You know, obviously, when things move out, there's additional costs. There's no doubt because we have to continue to support. But it's not significant cost to us. No.
Speaker 5
Okay. Thanks, Tom.
Speaker 2
Yeah. You bet.
Speaker 0
Our next question or comment comes from the line of Gautam Khanna from Cowen.
Speaker 6
Following up on Ron's question, I was a little curious. The implied aftermarket sales were down to, whatever, dollars 63,000,000 or something in the quarter, which is lower than the last two quarters. And we've heard like General Electric had talked about a fairly significant sequential ramp in their in spares in their quarter. Honeywell saw a big pickup sequentially as well. I'm just curious, do you any lumpiness or anything you could point to that was are you seeing anything since the quarter where you're starting to see evidence of demand picking up?
I'm just curious what might explain the difference between you and some of the other guys.
Speaker 2
Sure. You know, there's always variability in the aftermarket, you know, depending on product you make and timing. You know, as I mentioned to Rob, we are seeing, increased forecast coming in terms of, like, engine shop visits. We're starting to see activity in terms of, you know, RFQ activity for, you know, inquiring about spares. So, you know, we do see another one as the the MAX starts to come online, both, you know, production ramp, but also, reintroducing the parked aircraft.
We do anticipate and are seeing signs of increased initial provisioning sales. So we do have confidence that as we move through our fiscal year, we are going to see a ramp up. So I think it's just between what you saw from GE and Honeywell and ours is it's in the normal quarter to quarter variability. I I don't think there's any disconnect, between the companies and the markets. You know?
So I think you'll start seeing Okay. Sequential improvements as we move through the year.
Speaker 6
Okay. So you think the December sort of marks the trough based on what you're seeing today?
Speaker 2
It definitely, it's you know, we're down at the bottom. Now you know, how fast you come out of that trough, you know, there's no doubt about that. But, that we're down at the bottom, but we we do anticipate we're we're gonna be increasing as we move forward.
Speaker 6
K. You know, one other question, and forgive that it's a nonoperating one. But, you know, the nonsegment I'm just trying to get get a sense for what the nonsegment would be on the next items onetime items basis. And, you know, the tax rate was also fairly low this quarter. And maybe, Bob, can you comment on, you know, what which I don't wanna be wrong in our modeling because of those items.
So if you could maybe baseline us on what we what we should be utilizing for And tax
Speaker 3
From the first quarter is always a little heavy for us for nonsegment compared to the full year. The onetime items we had, if you recall, and you'll see this later in the it's in the back of the release also, was the gain on the sale of Duarte and the impairment of the RPS asset. So that's what we took out to get to a more run rate oriented. So you'll you'll see a decline to a more consistent level with the prior year as we go through the year.
Speaker 6
Okay. And and tax rate as well? Or what Yeah.
Speaker 3
Tax rate will probably hover in this area a little bit higher, you know, in the 18% range overall as we go through the year.
Speaker 6
Okay, thank you. I'll get back in queue. I appreciate it.
Speaker 0
Thank you. Our next question or comment comes from the line of Christopher Glynn from Oppenheimer. Your line is open.
Speaker 4
Thank you. Good afternoon, good evening. Nice job on the cash work.
Speaker 3
Thank you.
Speaker 2
I was
Speaker 4
curious, the incremental margin sequentially for industrial, 65%, 70%. Just wondering with RPS more getting a little room behind you on that divestiture and some restructuring, is is the kind of mid teens level sustainable now or substantial variability still expected on on that? You know, if we could remove the variable of, you know, pandemic might be in such a way in subsequent months?
Speaker 2
Yeah. Well well, first, what I'd say is, we're we're committed and working hard on, you know, increasing our industrial margins like we've talked, over the last couple of years. So some of the improvements have come from the divestiture, cost reductions. But we did have in the quarter, we had really a favorable margin mix on products. As we move through the year, it'd be aggressive to say that we were going to hold at that level, but we definitely are going to be year over year improved, industrial margins.
And you know, as we're we go through the year, we have to see how that margin mix plays out. But year over year, industrial will definitely be improved. Mid mid teens is a little on the aggressive side for this year, but that's the path we're on.
Speaker 4
Okay. And just defense, several quarters in a row where the supply chain issues and some absenteeism have seemingly impacted that end market with those kind of specific criteria more than your other end markets. I'm just, curious about, you know, why there, what you're seeing, and as, know, supply chain issues ease, does defense have, you know, a a nice rebound just structurally kind of waiting for the the start date type thing?
Speaker 2
Yeah. What what I'd first say is we've got a really strong backlog in defense. A lot of our defense sales on on aerospace come out of our Santa Clarita site and also our Nile site. But, California had with the pandemic, was hit hard. We had severe absenteeism, supplier issues to where we didn't get out due to that.
The sales weren't as as high as they could be with the backlog we had. So we do have that backlog, which we will be able to you know, sell through the the remainder of the fiscal year. So we expect to have the you know, a dent in that as we move forward. And it just happened to be location specific and supplier specific problems, and it it happened to hit the defense side harder than it did our commercial side just due to location.
Speaker 4
Great. Thanks for the color.
Speaker 2
Yep. You're welcome.
Speaker 0
Thank you. Our next question or comment comes from the line of Pete Skibitski from Alembic Global. Your line is open.
Speaker 7
Hey, good afternoon, Tom and Bob and Don.
Speaker 2
Hey, Pete.
Speaker 7
Switching back to industrial, guess, Bob, can you give us maybe a ballpark of how much China CNG was up in the quarter?
Speaker 3
I couldn't give you a specific, but it was significant in the quarter.
Speaker 8
Was significant? Okay.
Speaker 3
Yes. Know, Pete, you've followed us long enough how volatile that could be, right? So that's one thing that's extremely difficult for us to peg any given quarter.
Speaker 7
Yes. That was kind of my second question. The language on the slides, it seemed to indicate that you guys thought that maybe sequentially that China CNG could be down on revenue. Is that just, I guess, because of seasonality? Is that what you guys are expecting?
Speaker 2
Well well, one you always have to look at is the Chinese New Year, and the Chinese New Year always slows down production. You kind of look at it as our holiday season, less working days, slows down production. So in the first calendar quarter, you definitely have that. We do see variation depending on oil or diesel and gas pricing spread. There was some volatility in that.
It's coming down. Gas has now dropped quite a bit and is in good place moving in the right direction. We also see positives going forward. And you just have to expect some volatility in that market. But positives going forward is there is still the regulations, emissions compliance regulations coming up where we're gonna see higher use of natural gas.
The, China six regulations on diesel engines goes into effect in July. That's favorable to natural gas powered trucks. So we see some positives going. But due to seasonality and some just normal variability in that market, we always have to be a little cautious. But the trends are in the right direction.
Speaker 7
Tom, are you expecting another buy ahead like in like the June in front of China six? It seems like you had some buy ahead last time.
Speaker 2
There were some buy aheads. But one one thing that's a little bit different is there's some restrictions that are gonna go into place in various large, cities that won't allow, non China six trucks to come in. So I think there'd be maybe some buy ahead, but it might be more limited than in the past. Our
Speaker 0
next question or comment comes from the line of Greg Conrad from Jefferies.
Speaker 9
Just a follow-up on commercial aerospace. I mean, you mentioned some sequential improvement on narrow bodies. But what do you think on the wide body side, given some commentary around destocking and some further rate cuts on the wide body side?
Speaker 2
Well well, we definitely, you know, have seen the rate cuts on the the widebody. And, I think yeah. We would say from a Woodward impact that the inventory destocking has occurred. You know? So that that, I think, you know, we believe has occurred.
But the, you know, the rates are down low. We're, you know, we're we're working with our OEMs on on those rates, but, you know, we definitely do anticipate wide bodies are gonna take a a fair amount longer than the narrow bodies to recover. And that's that's built into our production plans and interact you know, in our activity. Yeah.
Speaker 9
And then just the the decremental in aerospace has been held pretty constant at, you know, a little bit over 30% despite maybe some unfavorable mix with the aftermarket, at least in the quarter. I mean given some of the productivity improvements and cost takeout, I mean how are you when this market does turn, how are you kind of thinking about incremental margins?
Speaker 2
Yeah. You know, the one thing you're highlighting is, something we'll be looking forward to. You know, we we were, have facilitated and have the capacity to handle much higher rates. So that that's had an effect on us to be operating below capacity, as we move forward. You know, first thing I'm saying, you know, Bob, you may wanna jump in and comment too.
With the margins we have in aerospace and the 30% decremental is actually fairly good given the the significant volume drops. You know, we would expect to see that reverse on the other on the other end as we ramp up. But I don't know if Bob can add anything to that.
Speaker 3
Yeah. You know, early on, when the pandemic started, I threw out a a 40%. You know, we didn't know and and and still really don't know how it's all gonna pan out, but we thought it would be much higher. And so I think it speaks to a lot of the cost actions that everybody took that have kind of blunted that on the downside. We would hope that because of those same reasons that we get some leverage as we come out, but we've got a ways to go to get capacity up first.
Right? So as Tom said, we get a very a lot of capacity available and a lot of capital that's not being employed. So once we get that humming, we should see some nice incrementals going forward.
Speaker 9
Thank you.
Speaker 0
Thank you. Our next question or comment comes from the line of Chris Howe from Barrington Research. Your line is open.
Speaker 4
Good afternoon, everyone.
Speaker 2
Good afternoon. Following
Speaker 4
up just on some of
Speaker 2
the questions we went through.
Speaker 10
As it pertains to the last one, the longer this is prolonged as it relates to an aerospace recovery, Can you talk about how this may change your outlook as far as this perhaps accelerating the rate at which we go into a recovery? And along that same path of thinking, for the industrial segment, you mentioned the gas turbine expectations, not being so influenced by the pandemic. Perhaps, some additional insight into the positives you're seeing in the industrial segment. Who knows how the current administration will help economic growth as far as infrastructure spending? But some more detail on the positives there that may offset some of
Speaker 2
the continuing pressure that you're seeing in the industrial markets. Thanks. Sure. You know, in particular, on the turbomachinery side, I think it's everybody's well aware, you know, that market was down for a long time, and it it it was depressed. What we're seeing right now is that, you know, the inventory had been really pulled out of pulled out of the pipeline.
You know, the market was down. But now we're starting to see the order books starting to fill in. We're seeing pent up demand in the aftermarket. So we we really think that in that gas turbine and the rest of the turbomachinery steam turbines compressor market that, we're only gonna head up, you know, that there really isn't Mhmm. Really any more room to go down.
We we just don't see it happening. So all indicators are pointing up. As we move through the year, we we see the order book filling in and that we will have enhanced sales, and that's part of our business going forward. So that's why we highlighted that things are all moving in the right direction. The orders are starting to flow.
The RFQ activity is picking up, and that's globally. So we, you know, we feel pretty confident that that's on the upturn. I think the other question was on, you know, the commercial aerospace market. And I think a lot of you have, you know, saw what happened over the holidays. There there's a huge we believe there's a huge pent up demand for travel.
And as soon as vaccines get out a little more, we're gonna see we're gonna see a lot of people heading heading, on trips and, you know, probably first leisure travel business will pick up, that more aircraft will, you know, get into service, that the utilization will go up. And we also you know, I I commend the airlines for the job they've done during this pandemic and how they've managed utilization and how they've been able to, you know, keep keep the aircraft flying and safe, but to balance off when they needed, heavier maintenance. So that that is gonna come our way. It's just a matter of timing. And, you know, we're beginning to see indications that that's picking up.
So, you know, as long as the vaccines get distributed and, you know, people get a little more confidence, I I think you're gonna see, more rapid recovery in commercial aftermarket, and, you know, obviously, up by the ramp ups that, you know, the, narrow body, players are talking about for, you know, the Neo and the Max, and then that hopefully will follow-up with some international travel, and then we'll start seeing maybe some, production rate recovery on the wide bodies. But that that'll take a little longer.
Speaker 4
Thanks, Tom. I appreciate your color as always. I'll hop back in the queue, to give others a chance. Thanks.
Speaker 2
Okay. Thank you.
Speaker 0
Thank you. Our next question or comment comes from the line of Michael Ciarmoli from Truist Securities. Your line is open.
Speaker 11
Hey. Good evening, guys. Thanks for taking the question here.
Speaker 2
How are you?
Speaker 11
Maybe I don't know if this is Tom or Bob, but you gave us a little bit of color on the industrial margins and kind of what to expect. Looking at aerospace, it's kind of a big sequential decline. And thinking about, I guess, the recovery here, it seems like the OEM, you had that sequential improvement. I'm assuming there's a little bit of a mix issue there with OEM margins below aftermarket. And then you talked about the guided weapons in that segment being down.
I think you've historically said those are pretty good margins. Should we think that this 14.5% level could stay if aftermarket is a bit squishy this quarter and you get an uplift in OEM, does that put more pressure on margins? Or just anything you can give us about the margin trajectory maybe here in aerospace?
Speaker 2
Yeah. What I what I would say is, a lot of it is based on recovery, and, you know, we we anticipate commercial aftermarket to recover. We we also expect, you know, to, have higher military aftermarket and OE sales going in the the remainder of the year. You know, that'll that'll help the mix. And I I guess I would just say that as we look at the full fiscal year, we do anticipate that our aero margins are gonna improve throughout the fiscal year.
And, you know, as the volumes recover and and the aftermarket activity takes place, you know, I'm I'm highly confident you'll see, you know, Woodward back up in that 20 plus percent, you know, segment margins for Arrow. That may take us into fiscal year twenty two to get to those numbers, but we will be ramping through the year if, you know, the, outlook and, recovery and travel picks up. You know? So we always gotta say there's still that volatility uncertainty out in the market. But it it, you know, definitely was, you know, during this quarter, was a tough tough quarter on on the mix and the volume.
I do wanna address your question. There's no doubt, you know, our aerospace model is the aftermarket carries higher margin than the OE. And so if you get, higher OE without aftermarket enhancing you increasing, you will see some pressure on your margin. So that that that that is a true, you know, point that, our business has. And, but we see everything moving in the right direction going for the aerospace segment going forward, through the fiscal year.
Speaker 11
Got it. Can you maybe just on that, can you talk, Tom, maybe your current utilization at at Rock Cut facility? I mean, give us a sense of, you know, where you are in terms of capacity. Because I would give you imagine as some of those OE lines come back on even though they're diluted versus aftermarket. Maybe you get some better absorption.
I mean, can you give us a sense of where Rock Cut is right now?
Speaker 2
Yeah. There there's no doubt we're gonna see real leverage, on the upswing. You know, I would say Rock Cut's probably operating 40% of capacity. Okay. So we we have that we have a lot a lot of capacity.
And that that's one thing everybody should take away is that, you know, those investments have already been made. And during this downturn at all of our facilities, including Rock Cut, we're we've been improving the production lines, doing a lot of continuous improvement at Kaizen activity. And it's all been in preparation so that when we do recover, you know, the markets recover, you know, we're improving velocity. That'll help working capital. We're improving, you know, the the production lines.
So to improve productivity going through those lines. So we haven't just been sitting during this pandemic. You know, we've we've been looking at it saying, hey. We're gonna fix you know, we're gonna improve all of our production lines. We're gonna come out of this stronger.
We have the capacity. We've got good investment in there, and we're going to have high leverage on that when the volumes recover or as they recover.
Speaker 11
Got it. Got it. Just on last one for me. Just on the working capital, it looked like inventory is up a little bit. You had a great free cash flow quarter, obviously.
But how should we think about maybe inventory specifically and planning for that recovery and OEM rates may be kicking higher and being ready for that aftermarket. Do you think inventory investment is going to be a
Speaker 3
bit of a headwind to cash? It normally would be as we come back, but we've kind of talked from time to time about all the operational enhancements and improvements and true north work that we've been doing and so on. So we are fairly confident that we're going to be able to offset what would normally be the pattern. And so working capital needs would be a headwind as we go forward, we still anticipate the receivables will be as things improve, hopefully, throughout the year. But we're feeling much better about inventories in terms of progress we're making to bring down our overall levels and counter some of that natural clearly, we'll have to increase inventories to cope with increasing sales.
But hopefully, we'll be we have brought the base down and we'll continue to bring the base down so that we won't see significant inventory movement as we recover.
Speaker 11
Got it. Perfect. Thanks a lot, guys.
Speaker 0
Thank you. Thank you. Our next question or comment comes from the line of David Stress from Barclays. Your line is open.
Speaker 12
Thanks. Good evening.
Speaker 2
Good evening. Hi.
Speaker 12
In terms of what you're gonna do with the with the cash, are you just going to use continue to use excess cash to delever now that you've readjusted the dividend? Or would you expect to get back into the repo market? And guess, how are you thinking about your M and A pipeline at this point?
Speaker 3
Otherwise, just I'm sorry. Go ahead, Tom.
Speaker 2
Go ahead,
Speaker 3
Bob. Go ahead,
Speaker 2
Bob. Yes. You
Speaker 3
saw, one, we got the dividend back to our pre COVID level. So that was kind of step number one. Step number two is probably gonna be more along the lines of growth. We have plenty of organic opportunities to invest in. We have inorganic opportunities to invest in, and we'll continue to watch for opportunities as they arise.
The repo market, we've said that we are normally kind of we'll watch and see where the share price is and so on. But while we continue to believe we're always
Speaker 0
a good
Speaker 3
investment, at this point, I don't really have a lot of plans to get back into the repo market going forward. On the debt side, the great news, we kind of paid off all of our short term prepayable debt. And so there's almost the entire revolver is available to us. And we really don't now for a number of years have any tranches of long term debt due. And the last L'Orange acquisition gave us a fantastic opportunity to spread the debt out over the next it was at that time about fifteen years, and now we're probably thirteen to twelve years.
So I think we have a great runway with a lot of balance sheet strength, not a lot of debt due, some cash coming in, and it'll give us some great opportunities.
Speaker 12
Okay. And without obviously giving us all the moving pieces in terms of free cash flow and earnings, Bob, would you expect this to be another year where your cash conversion is over 100% of net income?
Speaker 8
I would.
Speaker 3
We'll see how the year pans out. But obviously, this was a strong quarter. We don't anticipate that every quarter is gonna be as strong as this quarter was. I mentioned no headwinds related to receivables if and as we recover, but we do believe it will probably be north of the 100%, yes.
Speaker 12
Okay. And then last one for me. I know you guys aren't giving full year guidance, but in the past you've talked about kind of what to expect sequentially for the next quarter. Would you expect Q2 to be an up sequential quarter from an EPS standpoint or more in the flattish range?
Speaker 3
I think the first part of your comment was the right part. We were not giving guidance.
Speaker 11
Okay.
Speaker 3
So yeah. Yeah. Yeah. It's very hard to you know, minute, everything's looking great on on vaccines. The next minute, we got all sorts of problems.
We can't get them out. I agree with the comment Tom made. I think there's a tremendous amount of pent up demand and so forth that'll really get passenger traffic going again. But when and how quickly? I think there was an earlier question about the prolonging of the pandemic and what impact that might have.
So I think it's just too early to be able to see what's gonna happen in the remainder of the year,
Speaker 2
much less the next quarter.
Speaker 12
All right, guys. Thanks very much.
Speaker 2
Yes. Thanks. Thank you.
Speaker 0
Thank you. Our next question or comment comes from the line of Noah Poponak from Goldman Sachs. Your line is open.
Speaker 8
Hey, good evening. Good afternoon.
Speaker 2
Hi, Afternoon.
Speaker 8
Doing the time zone math there on the phone.
Speaker 0
Yeah. Actually,
Speaker 8
following David's question there on the sequential kind of walk. For the aerospace segment and looking at its revenues, you know, we all look at year over year all the time for everything, for a variety of reasons. But in this very unique environment it's sort of helpful to look at the sequential if you can sort of envision where the bottom is and then walk along the bottom and then decide when the recovery occurs. But your aerospace segment is really unique. If I look at the last really kind of five to ten years, it just has a lot of seasonality.
There's several years where the 1Q to 4Q is, you know, something close to $100,000,000 Does that seasonality hold in your fiscal twenty one, even if there's literally no end market change through the year? Or is that out the window given the very unique environment?
Speaker 2
I think we would say we'd still see seasonality. It'd just be the magnitude of it. But some of that's just due to working with our customers, you know, fiscal year versus calendar year activity and the not a working days, you know, in our first quarter, those all play into that, and, that that type of seasonality is still out there.
Speaker 8
Okay. So so the sort of low $300,000,000 run rate that the segments had, you know, you're gonna move off of that not insignificantly just on seasonality alone. And then if you get, you know, an actual end market pickup towards the end of the year, know, that would be on top of that.
Speaker 2
I I would say that's correct. You know, we we definitely will see the seasonality. The tougher part, you know, is and, you know, we watch very closely. We we are and we're very conservative during, you know, the crisis on our outlooks. And, you know, I think that paid off.
And, you know, we monitor everything daily. And as we see, you know, order activity, shop visit activity, those things picking up, you know, we're we're react quick to that. But our outlook is as we move through the fiscal year that we will see per you know, OE volumes pick up, and we will see aftermarket volumes pick up. That that's our outlook, but we're cautious about the volatility and, you know, second second dip, happening. But outside of a second dip, yes, we're we're on a sequential quarterly improvement.
Speaker 8
Okay. Okay. The defense business, do you expect that to end up with a positive year over year growth rate for the year?
Speaker 2
Yes. We think it it should be slightly up flat, slightly up Okay. Over
Speaker 8
In the oil and gas business where you noted an up a recent a little bit of improvement in some of the leading indicators there, what's the lag time that we should think about from those leading indicators you're referring to and the revenues in your business?
Speaker 2
Yeah. The first thing and we we we're seeing some you know, we we monitor rig count and then, you know, meaning how many rigs are in service.
Speaker 11
Mhmm.
Speaker 2
You know, looking at the activity of the, you know, starting with starting with the, drilling activity. Second we're looking at is with customers is their plan to, return equipment to service. And you could say it's very analogous to what happened in the commercial aerospace market. A lot of equipment was, parked, mothballed. That equipment, they're starting to look at.
And so we're starting to see some aftermarket activity, meaning, requests for quotes, you know, some parts ordering starting to happen. Our our big OEM customers in those markets are talking to us about potential, you know, that they're seeing an increases. So we we have some positive signs, but it's it's not all firmed up yet, but it's those are the things we track. And, if we continue to see oil move in the 50s to $60 a barrel range, we should start seeing a pickup in the second half of our fiscal year.
Speaker 8
Okay. That's helpful. And then just one last one for me. I'll just try to follow-up on the free cash line of questioning as well. I just kept the remaining three quarters of the year exactly flat year over year, Maybe that's not quite fair for the March because that sorta, most of the March isn't yet impacted by the end markets.
But given what you just did in the first quarter, maybe that is fair. So I guess if I did that, the free cash for the year would be up 30% plus. Mean, you attacked the cash flow savings items that above and beyond what you'd normally be doing enough that you could have very significant double digit growth in free cash flow this year? Or is there a pull forward in the first quarter here?
Speaker 3
Yes. I think the error in that is kind of the way you know, there's no way last fiscal year was kind of a normal year for us. You know, it's kind of the tale of two halves. Right? The first half started out normal, and then the second half was totally different from what you would normally see from a seasonality perspective and everything else.
So the latter part, in particular, fourth quarter, were not very normal. And and this year, I'd I'd like to think it would be the tale of two halves going the other way. But in terms of recovering in the second half, I don't know that it's gonna be that strong. So so I I I don't think that you could take that approach and come up with a reasonable number. And outside of, you know, giving you a specific number, and we said we're not gonna give guidance, it's kinda hard to to give an outlook on that.
Speaker 8
I guess I was thinking second half of last year had the end market, the major end market headwinds. But I guess it sounds like your point, Bob, is that you're then you have a source of cash from working capital and there's abnormalities in what you're doing outside of the business segments that you wouldn't have if things are recovering.
Speaker 3
Yeah. Because it was you know, sales were down, but but working capital was was flowing cash. Right. So If
Speaker 8
you're recovering that's not happening.
Speaker 3
Exactly.
Speaker 8
Okay.
Speaker 3
Not to the same extent, but Right. Yeah. I
Speaker 8
see. Okay. Thanks so much.
Speaker 3
Thank you.
Speaker 0
Thank you. Mr. Gendron, there are no further questions at this time. I will now turn the conference back over to you.
Speaker 2
Okay. Well, I'd like to thank everybody for joining us today. You know, it's been a you know, the last year has been quite the quite the year, quite the roller coaster. I I think Woodward's managed and our our whole membership has managed the crisis quite well. We feel that we're coming out of it, and we look forward to the next couple quarters reporting back to you.
And if if, you know, we start seeing the downturn on this pandemic, we're gonna look forward to improving results moving forward. So thanks again for joining us. We look forward to talking to you over the quarter. Good night to everyone.
Speaker 0
Ladies and gentlemen, this concludes our conference call today. If you would like to listen to a rebroadcast of this conference call, it will be available to you today at 07:30PM Eastern Standard Time by dialing 505056 for a U. S. Call or 045373406 for a non US call and by entering the access code 200000419369. A rebroadcast will also be available at the company's website www.woodward.com for fourteen days.
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