Woodward, Inc. (WWD) Q2 2021 Earnings Call Transcript

Thank you for standing by. Welcome to the Woodward, Inc. Second Quarter Fiscal Year 2021 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. 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 second quarter fiscal year 2021 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 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 May 17, 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 3. 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-19 pandemic. Those elements can and do frequently change. Please consider our comments in light of the risks and the 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 will help in understanding our results. Now turning to our results for the second quarter. Net sales for the second quarter of fiscal 2021 were $581 million compared to $720 million for the prior year quarter. Net earnings and adjusted net earnings for the second quarter of 2021 were both $68 million and $1.04 per share. For the second quarter of 2020, net earnings were $91 million or $1.41 per share, and adjusted net earnings were $104 million or $1.61 per share. Net sales and net earnings were up 8% and 64% respectively, when compared to the first quarter of 2021. Net cash provided by operating activities was $219 million for the first half of 2021 compared to $52 million for the same period of the prior year. Free cash flow and adjusted free cash flow for the first half of 2021 were both $206 million. For the first half of 2020, free cash flow was $23 million and adjusted free cash flow was $55 million. Now I will turn the call over to Tom to comment further on our results, strategies and markets.

Thank you, Don, and good afternoon, everyone. The second quarter of fiscal year 2021 showed improved results from our first quarter and we believe our markets will continue to improve for the remainder of the year and into 2022. The aggressive actions we have taken to address this unprecedented crisis continue to drive strong cash flow, improve our liquidity and overall financial position, enable ongoing investments and opportunities for growth. While COVID-19 vaccinations gained momentum, increases in cases persist across the globe, continuing to drive uncertainty with respect to the pace of economic recovery. Moving to our markets. Aerospace continues to feel pressure, although it is encouraging to again see the sequential improvement from the prior quarter. The sustained depression of global passenger traffic resulting from the pandemic continues to impact commercial aerospace markets. However, we are seeing positive indicators, such as improving passenger traffic, increasing aircraft build rates and utilization and the return to service of the Boeing 737 MAX. Importantly, production rates of the MAX, in which we have significant content, are expected to increase during the year. We're encouraged by these trends and expect the continued vaccine rollout to have a positive impact on commercial aerospace. Defense spending remains strong with respect to both OEM and aftermarket activity. We see continued strength in guided weapons through the remainder of this year with moderation expected next year. Turning to our industrial markets. The power generation demand for gas turbines remains steady at historically low levels, although we anticipate a recovery in 2022. Aftermarket activity is starting to recover, largely driven by depleted inventories and resumption of maintenance projects. Global energy production continues to shift to natural gas and renewable support initiatives to reduce emissions. In transportation, China natural gas truck demand continues to be strong driven by favorable pricing and increased regulations to improve emissions. Government initiatives supporting natural gas trucks are also emerging in several other countries. The global marine market is showing signs of improvement with increases in both demand for new vessels and global freight pricing. Repair and overhaul projects that were postponed due to the pandemic are also beginning to pick up. The oil and gas market remains challenging. However, global demand and increase in oil prices are beginning to drive investment in drilling, fracking and natural gas compression. In summary, we delivered strong financial performance as our markets showed signs of economic recovery. We will continue to closely monitor this situation as we progress through the back half of the year. As the pandemic unfolded, we reacted quickly to navigate the uncertain market environment, reduce our cost structure, increase our focus on operational excellence and prioritize diligent cash management. In addition, we continue to gain market share in both our Aerospace and Industrial segments and we won new programs during the downturn. We believe Woodward is emerging from this unprecedented crisis as an even stronger company. Now, before turning the call over, I want to announce that Bob Weber intends to retire in January of 2022. He will retire from his role as Chief Financial Officer effective September 30 of this year and will serve as a special advisor to me for an interim period. I want to thank Bob for his dedication and valuable contributions during his more than 15-year tenure at Woodward. Under Bob’s leadership, the company has grown tremendously and we have delivered exceptional value to our shareholders over his career. I truly appreciate the partnership and friendship we have built over the years, and I’m excited for him as he enters the next phase of his life. Bob, we wish you and Patty all the best. We also announced that Mark Hartman, who is currently our Senior Vice President, Finance and Corporate Controller, will be appointed as Chief Financial Officer effective October 1. I look forward to working with Mark in his new role in leveraging his extensive experience to drive Woodward’s continued growth and success. Now I’ll turn the call over to Bob to discuss our financials in more detail.

Thank you very much, Tom. Aerospace segment sales for the second quarter of fiscal 2021 were $365 million, an increase of 23% from the prior quarter. Commercial OEM and aftermarket sales remain weak compared to the prior year as a result of the pandemic with commercial OEM down 30% and aftermarket down 42%. On the bright side, sequentially, commercial OEM was up 34% and commercial aftermarket was up 18% driven by increasing build rates and passenger traffic. Defense OEM was down slightly in the quarter compared to a strong second 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 down compared to the prior year quarter, although activity and backlog remain solid. Aerospace segment earnings for the second quarter of 2021 were $69 million or 18.9% of segment sales compared to $118 million or 24.8% of segment sales for the second quarter of 2020. The decline in segment earnings compared to the prior year was the result of lower volume, partially offset by cost reduction initiatives. Turning to industrial. Industrial segment sales for the second quarter of fiscal 2021 were $217 million compared to $246 million in the prior period. Excluding the renewable power systems and related businesses, which I will refer to as RPS, industrial segment sales for the second quarter of 2020 were $215 million. The slight increase in industrial sales, excluding RPS, was primarily due to strong demand in the current quarter for China natural gas engines and the positive effects of foreign currency exchange rates, partially offset by weak oil and gas and the ongoing impacts of the pandemic. Industrial segment earnings for the second quarter of 2021 were $28 million or 12.9% of segment sales compared to $26 million or 10.6% of segment sales in the prior year. The increase in industrial segment earnings was primarily the result of cost reduction initiatives. For the second quarter of 2020, industrial segment earnings excluding RPS were $25 million or 11.6% of segment net sales. Industrial segment earnings as a percent of sales for the first half of 2021 were 14% compared to industrial segment earnings excluding RPS of 11.8% for the same period of the prior year. Improved earnings resulted from the many actions we have been taking to optimize our product portfolio and global footprint. Non-segment expenses and adjusted non-segment expenses were both $10 million for the second quarter of 2021 compared to non-segment expenses of $28 million and adjusted non-segment expenses of $11 million for the same period last year. At the Woodward level, R&D for the second quarter of 2021 was $28 million or 4.8% of sales compared to $35 million or also 4.8% of sales for the prior year quarter. The decrease in R&D was mainly due to the quarterly variability of project expenses and customer funding. SG&A for the second quarter of 2021 was $44 million compared to $58 million for the prior year quarter, which included $17 million in merger and divestiture transaction costs. The effective tax rate and the adjusted effective tax rate were both 13% for the second quarter of 2021. For the second quarter of 2020, the effective tax rate was 14.8% and the adjusted effective tax rate was 16.2%. Looking at cash flows, net cash provided by operating activities for the first half of fiscal year 2021 was $219 million compared to $52 million for the prior year period. Capital expenditures were $13 million for the first half of 2021 compared to $29 million for the prior year period. Free cash flow and adjusted free cash flow for the first half of 2021 were both $206 million compared to free cash flow of $23 million and adjusted free cash flow of $55 million for the prior year period. The increase in free cash flow and adjusted free cash flow was primarily related to effective working capital management and lower capital expenditures. We have reduced our leverage to 1.7x EBITDA at the end of the second quarter compared to 1.9x at the end of the prior year quarter. Lastly, turning to our fiscal 2021 outlook, the ongoing rollout of vaccines across many countries is driving optimism for economic recovery, but the enduring turbulence caused by the COVID-19 pandemic, including significantly reduced global passenger travel and new viral variants continues to cloud near-term forecasts. While we believe many of our markets will improve for the remainder of this year and into 2022, we will continue to withhold guidance as we navigate the uncertain economic landscape. This concludes our comments on the business and results for the second quarter of 2021. Operator, we are now ready to open the call to questions.

Thank you. Your first question comes from the line of Robert Spingarn from Credit Suisse. Please state your question.

Good afternoon. So I have a couple of questions, but I wanted to start with just on the aerospace margins. They're pretty good. And they're almost back to where you've been and with the tailwinds you have for the rest of the year with just fundamentals improving, you're going to have a mixed tailwind. Can you hit 20% plus margins here in fiscal third or fourth quarter?

Yes, it's a great question. As we're highlighting, we're not giving guidance. We definitely believe there will be an aftermarket tailwind coming as more aircraft are brought online and utilization goes up. So we're confident in our long-term guidance for both segments. So we're on the path to get there, Rob, so we just have to see how the market materializes, and as we get the sales growth, we're going to leverage that into improved profitability.

Okay. Tom, can you give us any detail or Bob on, in the aftermarket, if the improvement or how we think about provisioning versus regular spare sales as that improves stronger than the other?

Yes. Right now it's stronger on the repair and overhaul side than on provisioning, but we do anticipate as we move later this year into next year, we're starting to see provisioning recover.

Okay. And then Tom, I wanted to follow up on your comment. I think it was your comment on MAX that the rates will raise throughout the year through our calendar 2021. But I was hoping you could be a little bit more specific with your inventory position there and current rates. And then as demand recovers, I wanted to get a sense of how quickly you can ramp beyond 31, given that you're capacitized, I assume for 52 or 57. And at that point, is the gating factor just labor?

Yes. So you're correct that we're sized to support the higher rates, both for the MAX and the Neo. The good news as we come out of the pandemic is we have the capital equipment to support the highest rates that we anticipate that Airbus and Boeing will be going to. We're onboarding new members to support the ramp-up. We put together some innovative and extensive training sessions to some of our members we’re bringing back that were either laid off or furloughed. Others are new members. But we're very confident in our ability to onboard members to help support the ramp. The other comment on inventory and the system, the inventory was depleted. So there's a combination. We will see some inventory increasing. We're on track and ahead of the production. We will be ahead of the production rate ramp. There is still a lot of uncertainty around the production rates. So we're tracking with exactly what Boeing and Airbus are saying they wanted to achieve, but I think there's going to be some volatility in those rates over the next six to twelve months.

Okay. And just normally what's your lead time relative to Boeing's delivery to the end customer?

Yes. Normally, it's about four or five months.

Okay. All right. Thanks, Tom. Appreciate it.

Your next question is from Sheila Kahyaoglu from Jefferies. Please state your question.

Good afternoon, Tom and Bob, congratulations again. I'll maybe stick to one or two. Tom, I don't know maybe this is for you, a little bit on the aftermarket we touched on it, but Bob, a little bit on the short term, but also the longer term on your aftermarket. How do you kind of think about it? What's provisioning been historically of your sales and what does it look like? Does the way you sell to airlines change because of the pandemic at all? Or because you've upped your MAX content, of course, in the A320, so maybe you could talk about aftermarket expectations, both near term and longer term?

Sure. I'll start, Bob chime in anytime. But Sheila, the first – I kind of want to maybe lay some groundwork. As we look at the aircraft coming back into service and I guess it goes outside, most everybody knows that they're bringing the newer more efficient aircraft back in service. They're retiring some of the older aircraft. As we look forward, if we call it the demographics of the fleet are going to be very favorable. In terms of the aircraft, we have more content on. We're starting to see that just in utilization and aircraft being returned to service. The point of that is, longer term, we think we're going to have tremendous aftermarket revenue coming in as the aircraft are brought into service. Airlines start taking new deliveries of particularly new narrow bodies and new wide bodies, where we have significant content. So that's looking very favorable to us. We anticipate as those utilization rates go up, we're going to start seeing more maintenance in it. I think, as you're well aware of – some of what we've called legacy products, that's pre-neo and MAX narrow bodies the 2,500 CFM 56 are some of those are just seeing their first shop visitor come into their second. So we think the maintenance activity will start picking up, and again, very favorable to us. In terms of initial provisioning, as you would expect, the airlines are preserving cash and being careful about that. But as we start moving out of the pandemic, they start putting the planes into service, they start taking more of the MAX aircraft out of storage, into service. We think we're starting to see initial provisioning pickup and it's definitely a good part of our aftermarket mix. Maybe more in fiscal year 2022 than the remainder of 2021, I think it's going to take a little time for all those deliveries and for the airlines to start picking it up. But when we look out it's kind of going back pre-pandemic, our demographics are positive. Our market share has improved, utilization of the equipment we're on is going up, and that all signals improved aftermarket over the next years. I think it will be very favorable to us.

Just staying on this topic then, I guess kind of – I'm sorry if I missed it, did you mention what initial provisioning is an overall aftermarket sales? And as these MAX ship out of inventory, would you expect any initial provisioning with them, or those are all already allotted for?

No, Sheila, both – let's phrase this way that the MAX in storage, at least for the most part, have not been provisioned with Woodward equipment. So, as they get taken up and the utilization starts going up, we expect that to come. But that's what I'm saying, it's more of a – I think as we approach our fiscal year 2022, we will start seeing provisioning recover. It's been very low during the pandemic.

Okay. All right. Thank you very much.

Your next question is from Gautam Khanna from Cowen. Please state your question.

Yes. Thank you, and congrats Bob again. I guess we'll get you another comp on another call though still so…

That's all right. Yes.

All right. Okay, good. Well, I was curious about if you could talk about the exit rate on the aftermarket, was it – did it get better through the quarter in terms of growth? Or was it pretty consistent January, February, March, and what have you seen so far through the second calendar quarter through April on the aftermarket?

Yes, we're seeing, I would say month-over-month, the aftermarket improving. So yes, we're seeing the utilization, we're tracking weekly utilization on all the aircraft we have content on, and we're seeing shop visits starting to increase. So it's pretty much month-over-month. We anticipate that continuing, kind of in conjunction with aircraft coming back into service. So, as long as we see the steady improvement, I'm thinking you're going to see continued aftermarket growth.

Okay. Could you say anything about the product types where you're seeing it? Is it on the actuation? Is it on the engine components? Is it across both, any skew either way?

It's skewed towards the engine, Gautam, so I'd say that's where traditionally the engines our business supporting the engines has higher aftermarket than on the airframe. And that's just truly that the engines are always running. You generate more time and more aftermarket revenue from engines. So it is skewed that way.

Okay. And then related to that, is there anything – I mean, is it broad-based, or is it leads generally stronger than us? I mean, I just am curious, I imagine it is, that this just kind of, we look at where the flight hours are our highest, that sort of tracking to your business or?

Sure. As you're aware, the hours are the most in the U.S. and in China. And so that's definitely driving more of it.

Okay. But forward visibility at this point, into the second calendar quarter is pretty good. I mean, can you see through June what the expected shop that is supposed to be? Or is it still kind of very, very short lead time in terms of aftermarket?

We're seeing forecasts from our customers and for shop visits, but I would say there's still a fair amount of volatility in the market. We're anticipating increasing the aftermarket, we're planning for that. We're doing our own internal provisioning demand planning for that, but it is still volatile. There's still a fair amount of uncertainty around it, but our belief is it's going to continue to pick up, and we're getting ourselves prepared for that.

Thanks guys very much.

Your next question is from Pete Skibitski from Alembic Global. Please state your question.

Yes. Good afternoon, Tom and Bob and Don. I just wanted to get a better sense. Maybe Tom, for with two quarters left in the year, where your lack of visibility stems from, because I think consensus in general expects revenue to be up in the back half of the year for you guys you've lapped the tough COVID comps. So is it an issue where you expect revenue to be up in the back half of the year? It's just hard to kind of ballpark a range around the revenue. And then because of that, it's hard to ballpark a margin around that, is that kind of the logic that drove you to not reinitiate guidance?

There's still – even on the OEM production rates, we're still seeing – we don't see variability in the rate and we're still being cautious that all the rates are going to be met. So there's a little uncertainty there. And there’s definitely uncertainty in the aftermarket. All indicators are pointing to improvement, but it’s a challenging time to really nail those down. Second thing, is the definitely uncertainty wrapped around the MAX, how fast will the planes get delivered? Will China approve the MAX? What will the utilization be on those? There’s a lot of factors that are still not solid, but as we were trying to say, the indicators and the trend is going in the right direction, we look positive, but it’s really still with all that variability, very difficult to pinpoint the exact forecast. And then as you’ve pointed out with the mix issues that you can have on the aerospace side, it’s hard to pin down the margins, but we’re encouraged by the outlook.

Okay. Okay. Bob, do you want to say something?

Yes, the only thing I was going to add is, and we were kind of focused on the aerospace side, but there’s a lot of equal uncertainty on the industrial side as well. We’ve had the oil and gas and pricing firmed up a little there. Our China natural gas is always kind of a variable and so on. We’re seeing the marine market and that’s very impactful to L'Orange, start to show some signs, but they’re just – they’re totally to call even on the industrial side as well.

That was actually my second question. It was the marine market, not a particular expertise of mine, but you read these articles about bottlenecks, and ports and whatnot, and it’s hard to know, it seems, I guess short-term negative, but it also seems like maybe a positive that there’s a lot of ships out there with global trade picking up. So, I mean, there’s order flow picking up for you guys in marine? Is visibility picking up? I’m just wondering if you could maybe give us some clarity there, and maybe how L’Orange has done kind of through the down cycle, that’d be great. Thank you.

Yes. One thing you’re seeing is the utilization is increasing in the marine market in particular, if you want to say in the freight carriers. So, we’re seeing that. We’re encouraged by the order book, it’s picking up, and we’re also seeing LNG carriers order book picking up and utilization picking up on those. And those are very strong programs for Woodward, a lot of content on those. The cruise market, it’s kind of been dead and we’ve got a lot of content on the cruise ships, particularly through L’Orange and through our traditional business. We’re encouraged to see that they may be allowing cruises in the U.S. here. I think, the latest was maybe starting in July. And that gets firmed up. We think there’ll be some maintenance activities kicking in. That’ll be a positive. So those are things like Bob highlighted, we see them coming. It’s just exact timing is a little hard to predict, but overall, the marine market is recovering the order books are picking up; now, they are long lead time orders just so, I mean, they’re out, the order book goes out a couple of years lead time. So, but it’s in a positive trend and most importantly thing for us right now is the utilization with stripes, the aftermarket, and that’s encouraging.

Okay. I guess I didn’t fully understand cruise ships. It’s a pretty good chunk of L’Orange’s revenue?

Yes, it’s a good part of the business. Good high-tech products that go in there and go to aftermarket associated with the cruise ships and that, as you know, has been dead in the water. So…

Yes. No problem, tell me.

Would be – yes, exactly, it also be fair. We always say cruise ships, ferries, all that it’s just been not happening in the pandemic, and it’s that recovers that’ll be positive. And then, like I said, the utilization of the cargo carriers and the like is improving. So that drives good business. And then we’re encouraged by the order book. So it’s on a good track and, hopefully the second half of this year and the next year, we’re start to seeing some recovery in those, which will be good for our industrial segment.

Okay. Just last one for me, just on the guided weapons comments, fiscal 2022, are we talking substantial declines, 50% type declines or lower – okay go ahead.

No, we see some reduction in DOD orders for the smart weapons, which may be partially offset by foreign military sales, and the foreign military sales are not firm, but we anticipate moderation or a reduction, but it’s not that dramatic as you were highlighting.

Okay. Thanks very much guys.

Yes. Thanks.

Your next question is from Christopher Glynn from Oppenheimer. Please state your question.

Thanks. Good afternoon, everybody. Bob I’ll hold on for a couple of days on congrats.

Okay.

So on the – just curious, you had framed us a number of positive comments on utilization across transportation, marine and general turbo machinery, oil and gas, I believe too, are those kind of the best directional kind of indicators to think of in terms of fiscal second half having a little stronger volume than the first half?

Yes, we definitely anticipate improvements in those subsegments and industrial, again with some uncertainty wrapped around it, but we do see that and then traditionally, as we move into the fourth quarter of our fiscal years, generally one of our stronger quarters. So, we don’t see that changing this year either. If it’s positive on the outlook with uncertainty that those things materialize, but right now they’re on a positive trend. You kind of saw that here in the second quarter, where year-over-year we’re basically flat sales. So normally we wouldn’t say that’s real positive, but during a pandemic, we think that’s a positive trend with improvements coming.

Okay. Are there any revenue recognition, timing issues related to COVID and commissioning any equipment or anything like that for investors?

Nothing that I would say is material.

Okay. Last one for me on the aftermarket for aerospace, you had a real nice sequential pickup. Some – a number of others were kind of flat, maybe even down a little X business jet, including some of the bellwethers. So is that just depict the volatility out there in the market, or is there a structural aspect to your – is that the demographic shift already kind of being reflected?

Yes, I would say, because we’re analyzing every week the fleet and the utilization of the fleet. I definitely think it’s the demographics as we call it of the fleet are favorable to Woodward content. I think that’s what you’re seeing. Longer-term we’ve highlighted that for years going back to when we secured all the additional content on these new aircraft. I think you’re starting to see that materialize over the next number of years as they’re in service and they start hitting maintenance cycles. So, we think that’s a positive for us.

Interesting to see it out of the gate there. Thank you.

Yes. Welcome.

Your next question is from Chris Howe from Barrington Research. Please state your question.

Good afternoon, everyone. Thanks for taking my questions.

Hi, Chris.

Hi, Chris.

Hi. First off, starting with the China VI regulations, we’ve been talking about it a lot last quarter. I know it’s hard to get into the weeds with it for cautionary reasons on a quarter-to-quarter basis. But perhaps with these going into effect in July, can you talk about your expectations in the second half for this business? And your outlook in general, once the regulations are going into place, I know you mentioned there were some limitations to the potential upside there on the last call, just wanted to gain the right perspectives on that.

Yes. Good question. The China VI diesel regulations go into effect in July. The China VI for natural gas are already in effect, but what’s happening – typically happens every time you have a new emission regulation, we call it kind of pre-buy. So you’re seeing China V diesels being purchased right now. That’s having a little bit of an impact; it did here in the second quarter. As we move forward though, and you look at China VI diesel versus the China VI gas engine, the cost difference has been brought closer together, and the fuel price is very favorable to natural gas. The payback not only in reduced emissions but in operating costs to go to a natural gas engine truck is greatly improved. Just to give you a kind of ballpark, these are market forecasts for the truck, the natural gas or for – I’m sorry, all the heavy-duty trucks in China. Traditionally over the last number of years, it might have been approximately 7% to 10% of the fleet was natural gas. Talking to our customers and our folks on the ground in China, they believe that we might see on the order of 20% to 30% natural gas trucks as a percent of the total market going forward, which is a substantial market expansion. We expect to do very well in holding our market share or even growing the share. We have very high performing systems for China VI gas engines. So the expansion of that will increase as you go through the remainder of our fiscal year, but more importantly, as you go over the next couple of years, we expect the natural gas percentage of the total market to improve, and that’s a positive for our business longer term as that happens. Overall, the outlook is good, little volatility upfront, or as Bob and I would say there’s always volatility in the China market. So, we do see that, but the longer-term trend is very favorable as well.

Okay. That’s very helpful. And I have one follow-up. You answered some of my other questions on industrial as it relates to perhaps areas that could recover in the future. Moving to aerospace though, commercial aftermarket should recover first narrow, then wide body, as we kind of look at where we are now versus three months ago, and we moved to how we would term a new normal, which seems to be changing on a daily basis, but how should we think about incremental margin has been discussed a lot? Perhaps there could be an outsized sequential improvement quarter-to-quarter, but as we move into fiscal year 2022 and beyond, business is much stronger than it was pre-pandemic. What could we see as far as incremental margin in aerospace? Thanks.

Sure. I’ll take it and Tom can jump in if he wants. From the margin standpoint, we’ve said the way you characterize it aftermarket should come first followed by OEM, but the build rates are improving. So it’s not a huge shift in overall mixed between aftermarket and OEM, but we do believe it will be a tailwind. We’ve kind of been looking at analyzing it a lot of different ways and it’s very hard to triangulate on a lot of variables obviously, but we do believe as we go into 2022 and beyond, we should see a tailwind. We’ve had people ask us if it’s 25%, 27%, 30% segment margins extremely difficult to quantify, but we do believe it will be a tailwind.

That’s all guys.

Could you repeat that please?

Oh, that’s all the questions I have.

Oh, okay. Thank you.

Your next question is from David Strauss from Barclays. Please state your question.

Thanks. Good afternoon.

Hi, David.

So the 42%, I think commercial OE sequential growth that you saw this quarter that was much stronger than what we seen elsewhere, was there any easy comparison issue or what exactly drove that? Was there anything there besides just MAX being really low and starting to come back for you all, but we would have seen that with other companies as well?

Yes. Just to check the numbers. Well, we gave it was 42% down year-over-year and 18% up – you’re talking commercial aftermarket, right?

No, I’m talking actually commercial OE.

Oh, I’m sorry. So, that was down 30% year-over-year and up 34%.

Up 30%. Yes. I mean, that’s still, yes, I got the number.

Pretty significant.

Yes. So a lot more significant than what we see elsewhere.

Yes. And, and as Tom pointed out, it’ll be kind of lumpy. The timing all depends on a lot of the timing of shipments and so on and so forth. But I don’t know that we would expect it to stay at that level quarter-to-quarter.

Okay.

Yes. The only thing I would add is, if it’s comparing to other companies, as these rates pick up, they’re definitely on the programs we have gained high market share. So it’s – to me, it’s not overly surprising that we have good recovery in there versus maybe somebody that is more heavily weighted to legacy programs. That may be part of it.

Okay. How much of your new equipment – commercial new equipment and aftermarket is business jet related at this point in what are you seeing on the business jet side?

Actually, business jets came through the pandemic a lot better than we thought sitting here a year ago. Business jet markets is a good market for us. We’ve got content, I don’t know. We have that breakout, but we’re somewhere in a little bit north of 10% overall business and general aviation.

Okay. And then the last one Bob, I guess an update about how you’re thinking about your cash balance and what there is to do there. I assume you don’t want to be running with close to $300 million in cash on the balance sheet for too long.

Yes, no. We’ve kind of talked about getting back to our pre-COVID policies and directions, if you will, which was just kind of 50% of net earnings being returned to shareholders in dividends and share buybacks. But most importantly, we’re focused on growth. We’ve talked a lot about having a number of both organic growth opportunities; space and missiles is one of them we called out. We also have an inorganic funnel process, like so many of our peers do and we’re always looking at opportunities there. Our model is a growth mode. We believe that that brings the most value to our shareholders. And so no, we won’t let the cash pile up for very long.

Great. Thanks very much.

Your next question is from Noah Poponak from Goldman Sachs. Please state your question.

Hi, good evening everybody and congratulations, Bob and Mark on the announcement.

Thank you.

If we just looked at the sequential growth rates you had in the quarter in aerospace, original equipment and aerospace aftermarket, how would you expect the fiscal third and fourth quarter growth rates to compare to that just directionally, about holding the same faster or slowing down?

Well, a little bit chime in Bob as well, but a little bit I’d say the OE rates should pick up. The aftermarket, as I was highlighting earlier is a little challenging to predict probably will not be as high of a growth rate as we just saw, but we’ll continue to be, very solid growth rate going forward. Hopefully in the next few quarters, we’ll be able to give more color on that as we see things stabilize. We do anticipate continuing to increases in both sides of the market, OEM and aftermarket.

So Tom, just to make sure we’re speaking the same or talking about the same thing here, are you saying you would expect that the rate of growth you had sequentially in commercial OE, which, as David was just asking, was surprisingly high. You’re saying you expect that to stay the same or even pick up, or you’re just saying more that production rates are going to go higher. So that’s going to have some healthy growth rate for a while.

Yes, I think, I guess what I’ll say is I think the production rates are going to go up and we’re seeing overall still improved growth rate over the first year – over the second quarter. I think we’re saying that I expect the rate to improve, yes.

Interesting. Okay. With the commentary around guided weapons in fiscal 2022, are you anticipating that that will drive your total defense revenue to be down in fiscal 2022, or could it still grow?

It’s going to have a flattening effect on defense sales.

Okay. Yes. Makes sense.

Yes.

And then just one more on these aerospace margins, if I look back over the last several years, there’s some years where the second quarter is seasonally strong, the third quarter steps back down, the fourth quarter back up. It doesn’t happen every year, but it happens a decent amount of years. Is there any seasonal strength in the second quarter here where 3Q had stepped down a little and then 4Q maybe sort of in the zone of the second quarter, is that, and I guess, yes.

There’s a little bit of seasonality, and it’s really making sure the airlines are ready maintenance-wise for the summer season, and then later for the holiday season. So you do see a little bit of seasonality based on that.

So if I use that, and then I use the type of incremental margins you were just talking about a minute ago, year-over-year, it would imply the third quarter aerospace margin down a little bit and then the fourth quarter maybe sort of in the zone of the second quarter, is that, and I guess, yes.

And again, no, what I would say, when I highlighted that that’s a normal year.

Okay.

With somebody’s aircraft just getting back in service, I think the airlines, personally, I think they did a brilliant job of rotating assets and managing their maintenance costs, and they did as best they possibly could during the pandemic, but there is a pent-up maintenance bubble coming. That’s another thing that’s hard to forecast, but I absolutely believe you’re going to see that hit. It’s just exactly when it hits and I’m not sure it’s going to follow normal seasonality. That seasonality is real, but I’m not sure it’s applicable this year. So I’d just be a little cautious on that.

Okay. Interesting. Okay. Thanks so much.

You’re welcome.

Your next question is from Pete Osterland from Truist Securities. Please state your question.

Hey, good afternoon. This is Pete Osterland on for Mike Ciarmoli. Is there any additional color you can provide just on, directionally, how you expect margins and industrial the trends during the rest of the fiscal year? I know you’ve previously called out that margins. We’ll take a step back in fiscal Q2, but you expect that from this quarter’s level, they should be able to start showing sequential improvement again over the next couple of quarters.

They should. Yes. I mean, we’re going to have variability as we’ve kind of always had in the business, but some of the structural actions we’ve taken as we go forward should definitely provide the tailwind side of the equation. Now that the headwind side is we’re still not seeing any sales increases and one of the things we said we really needed to get to our targets, targets being 16%, 16% plus, was some increase in sales. Right now we’re – I think the buzzword is we are optimistic with respect to the remaining quarters of the year and going into 2022. But we really need to see the sales increase to get any leverage to be able to enhance the margins. I think we’ll see a tailwind. I don’t think we’re going to see our targets until we start to see a much greater sales increase than we’re seeing today.

Great. Thanks. And then just on costs, it looks like R&D was down about $4 million versus the prior quarter and SG&A down $12 million. I’m just wondering what was driving that decline. And what has it been the run rate for us to use over the next couple of quarters?

Yes, probably the midpoint between them. We’ve always got a lot of timing of things, project expenses, and things like that, that pop in and out of the quarters. We have some variability, so I would not say that the decline in both is sustainable. I think you’ll see somewhere in the middle between the 2% as we go forward through the year. We’re running at about a 4.8% rate. That’s pretty low for us usually. So, I think it was mostly timing this quarter.

All right. Thanks a lot.

We do have a follow-up question from Christopher Glynn from Oppenheimer. Please state your question.

Yes. Thanks. So, I just had a little housekeeping to close out. One was on the corporate spend, but I’ll take your SG&A comments as the answer to that. And then a tax rate for modeling purposes.

The forecast for the full year, we haven’t – that’s a good one to always try to guesstimate. The adjusted tax rate was 13%; 16.2% in the prior year; we’ll probably be above that 13% in the quarter but not necessarily significantly.

Okay. Thank you.

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

Okay, well thank you for everybody to join us today and thank you for your questions. We look forward to talking to all of you during our third quarter release. Have a good day. Thank you.

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