Woodward Inc (WWD) 2020 Q1 法說會逐字稿

Thank you for standing by. Welcome to the Woodward, Inc. First Quarter Fiscal Year 2020 Earnings Call. At this time, I would like to inform you that this call is being recorded for rebroadcast. (Operator Instructions)

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.

Thank you, operator. We would like to welcome all of you to Woodward's First Quarter Fiscal Year 2020 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 February 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 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. 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 financial information will help in understanding our results.

Turning to our results for the first quarter. Net sales for the first quarter of fiscal 2020 were $720 million compared to $653 million for the prior year quarter, an increase of 10%. Net earnings were $53 million or $0.83 per share compared to $49 million or $0.77 per share for the prior year quarter. Adjusted net earnings were $71 million or $1.10 per share compared to adjusted net earnings of $62 million or $0.96 per share for the prior year quarter.

Net cash generated from operating activities for fiscal 2020 was $27 million compared to $85 million for the prior year. Adjusted free cash flow was $29 million. Free cash flow was $53 million for the first quarter of 2019.

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. Woodward delivered a solid start to fiscal 2020, 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'd 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 2 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, reduce emissions and enhance safety, creating an exciting opportunity for Woodward-Hexcel to be at the forefront of such a critical evolution.

The financial benefits of the merger are compelling. For our respective fiscal 2019 on a pro forma basis, Woodward-Hexcel would have more than $5.3 billion 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 $1.5 billion share repurchase program within 18 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 of this year.

I'm pleased in collaboration with my Hexcel counterpart, Nick Stanage, to bring these 2 teams together. Over the next several months, we'll 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 2020. 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 737 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 in defense activity is helping us weather the delays related to the 737 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 $23.4 million. 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 million to $50 million and the related earnings impacts will be approximately 0 for fiscal 2020.

The divestiture will have a modest impact on 2020 margins and approximately 100 basis points of favorable impact on 2021 industrial margins.

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

We anticipate the strong demand for natural gas trucks in China to continue as the Chinese government enforces emission regulations and incentivizes 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 737 MAX are expected to be partially offset by stronger aftermarket in 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.

Thank you, Tom. Aerospace segment net sales for the first quarter of fiscal year 2020 were $474 million compared to $393 million 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 first quarter of 2020 as compared to the prior year quarter.

Despite uncertainty surrounding the 737 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 2020, 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 first quarter of 2020 were $93 million or 19.6% of segment sales compared to $73 million or 18.5% of segment sales for the first quarter of 2019. Segment earnings were primarily impacted by the higher sales volumes.

Turning to Industrial. Industrial segment net sales for the first quarter of fiscal 2020 were $246 million compared to $260 million 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 connectivity 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 first quarter of 2020 were $28 million or 11.5% of segment sales. Industrial segment earnings were $29 million or 11.2% of segment sales for the first quarter of 2019.

Adjusted Industrial segment earnings for the first quarter of 2019 were $39 million 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, nonsegment expenses were $51 million for the first quarter of fiscal 2020 compared to $29 million for the same period of the prior year. Adjusted nonsegment expenses for the first quarter of 2020 were $27 million compared to $22 million for the same quarter last year.

R&D spending for the first quarter of fiscal year 2020 was 5% of sales compared to 6% for the prior year quarter. The effective tax rate for the first quarter of 2020 was 13.3% compared to 20.1% in the first quarter of 2019. The adjusted effective tax rate was 17.1% for the quarter compared to 21% for the first quarter of 2019.

During the quarter, 1 of 2 parcels of the real property at our former Duarte operations was sold for $19 million, which resulted in an after-tax gain of $10 million or $0.16 per share. We anticipate the other parcel to be sold by the end of the third quarter of fiscal 2020.

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 noncash after-tax charge of $28 million 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 nonsegment results.

Looking at cash flows. Net cash generated by operating activities for the first quarter was $27 million compared to $85 million for the prior year quarter. Capital expenditures were $17 million for the first quarter compared to $31 million for the prior year quarter.

Free cash flow for the first quarter of 2020 was $10 million compared to free cash flow of $53 million for the first quarter of 2019. Adjusted free cash flow for the first quarter was $29 million, which includes the $19 million 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 2020 outlook as we look ahead at the remainder of fiscal 2020, our previously stated outlook has been updated to reflect the impacts of the 737 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 $2.9 billion and $3.0 billion. Aerospace sales are anticipated to be up low single digits compared to the prior year. We assume a return to service of the 737 MAX in mid-2020, and our build rates are in line with our customer 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 million of fully diluted weighted average shares outstanding. The increase in share count from 64 million to 65 million has a negative impact of approximately $0.08 for the fiscal year. As a result of 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 2020. However, within the 18 months following the close of the merger, we anticipate repurchasing approximately $1.5 billion 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 million.

This concludes our comments on the business and results for the first quarter of fiscal year 2020.

Operator, we're now ready to open the call to questions.

(Operator Instructions) Our first question comes from Robert Spingarn.

So a couple of things. I think, obviously, top of mind for a lot of people from the merger perspective, Tom, is this $1 billion target. And the fact that it didn't really reconcile with what consensus was for the 2 companies together. We've all talked about this since then. Is there any more color that you can add on how the 2 companies get there beyond the synergies since the gap is closer to about $250 million to $300 million?

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

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

That's correct. Sorry. Go ahead.

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

So Rob, as you'll recall, we, at the guidance for fiscal year '20, we had announced the target of $400 million of free cash flow. We're taking that up with the disposition of our Duarte facility. The first parcel of that to $420 million, that was effectively $19 million of proceeds, we would anticipate a further $13 million of proceeds when the second parcel closes in Q3.

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

No.

Okay. And then just as a last question, what is the -- and this is for you as well, Jack, you talked about a back-end weighted industrial year, some improvement in the back end. What gives you the confidence that the markets are going to evolve that way?

Well, yes. I'll pick it up first, and Jack can add to it. The first thing would be our order book, which is more back-end weighted this year. Recovery, we're seeing in the gas turbine market and the rest of the turbomachinery market. Those are longer lead programs. So we've got some good insight that those are recovering. Second half on China natural gas, the natural gas truck sales are higher. And so that outlook is in our forecast, and 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.

Your next question comes from Gautam Khanna.

Just following up on Rob's question. So if we take the $420 million of adjusted free cash flow this year and strip out dispositions. So you're slightly under $400 million, right? And then we take Hexcel's guide of $300 million plus, we're at $700 million. And I'm just wondering, is there something that's -- that we're -- that the Street is not understanding that CapEx comes way down in '21? Or is there some sort of kind of catch up? Or is this just the Street's mismodeling earnings, you guys are going to just come in, do you think you have a better fiscal '21 on tap than what right now is understood?

Yes. Again, it's basically the same commentary we've given before, but it's increased earnings, lower CapEx, synergy savings, all coming together. And that is -- and on top of that, we're anticipating improved working capital.

Okay. There's nothing on tax rates or something else that you can point to?

No.

Okay. And what's the CapEx guide implied in the fiscal '20 numbers right now?

$80 million.

Okay. Yes, 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.

Well, what we had, we had a strong quarter, it was 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.

The ongoing MRO is strong on commercial, but we're also seeing very healthy defense aftermarket. So overall, those are positives that continue as we look forward through the rest of this year.

Any sense for how much of the 14% growth in the quarter owed to initial provisioning? Was it 1/3 or some -- is there any sort of qualification you can give?

No. I don't have any, Gautam, at this time. Sorry.

It was a good initial provision, but it was very strong legacy MRO as well.

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

Yes. Look -- go ahead. Finish your question.

Sorry. And then the last one, 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 still...

Okay. I'll answer -- I'll get to both questions. First is, we're projecting mid-single digits for commercial aftermarket for the remainder of the -- 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 have -- we do have from our customers. So from Boeing, and we have a wide range of Tier 1 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 want to say, the Tier 1s have their own rates that they're looking at. Our outlook reflects those rates, and we think it reflects what Boeing is planning to do. And so we think that outlook is properly considered in our full year.

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

No. We've got it.

You've got it? Okay.

We've got it. Yes.

Your next question comes from the line of David Strauss.

So going back on the MAX, it looks like rough math, you've taken out maybe 300 ship sets this year, maybe down closer to in line with what Hexcel's talking about around 200. Is that correct?

Yes. I'd just like to highlight that the rate varies between Boeing and some of the Tier 1s, it's pretty consistent, but that's not way off. 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.

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

No. It's down from that. And we have not halted, but it's come down in line with the expected rates at 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 1s, and that's what we're running to.

Okay.

And as you know, it's a significant drop.

Yes. And then the -- in the bridge, you have a box that's cost containment. Can you talk about 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?

Yes. 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 the 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 surges in production, 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 going to go down, but then you're going to come back up and the type of product we make does require very skilled labor and a lot of special machinery that in specialty activity from our supply base that we need to retain. So we're working hard to do that. But we -- as we saw this coming, we were very aggressive on our cost actions. So that's how we're recovering some of that back.

Your next question comes from Sheila Kahyaoglu.

Wanted to ask about free cash flow. So following up on some of the ones that are asked already. Just 2 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?

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 believe our $400 million 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 million. 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 $420 million or better number.

Yes. 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.

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

Yes. If you look at inventory, we're in the 20 percentages -- points of inventory. And I really see that getting down 15%, 16%.

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?

Yes. What I would say, 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 once you look at that. So when we factor it in, we still have strong, strong OEM sales across the board, our aftermarket is strong, defense has been strong. So you take -- the 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.

Your next question comes from Christopher Glynn.

On the aerospace outlook, obviously, implies down revenue Q2 to Q4 is a 3-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?

Chris, I'd say that the balance of the 3 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 FY '19. We would not expect that to repeat in second quarter of fiscal year '20. But generally speaking, aerospace is flat the following 3 quarters.

Okay. And just in terms of the defense markets, it looks like they 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.

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

Flat, kind of exiting the year?

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.

Okay. And just wanted to lastly, checking on the L’Orange performance.

I think as we spoke to you 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 year 2020.

Your next question comes from Christopher Howe.

A good start to the year. A 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 compared to last on an aggregate basis and on a commercial aftermarket basis?

Do you mean year-over-year without MAX, is that what you're talking about?

On a pro forma basis, just trying to understand the underlying strength within aftermarket and then as a whole?

Yes. Yes. It's still strong. I 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, the biggest driver is legacy programs and the strong legacy aftermarket so.

Okay. Okay. 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?

Yes. Well, one, as we highlighted, the removal of the renewable portfolio from Industrial is about 100 basis points. And then the volume increases, which we're coming off -- we're coming off some lows that were in the turbomachinery market that's coming back. And then overall, we are also seeing productivity. So a combination of those is how we get to 16%, 16%-plus.

Your next question comes from Pete Skibitski.

Tom, how did the short-cycle businesses perform in Industrial in the first quarter, just I think people are still a little nervous about the global macro and the coronavirus? And I wasn't sure if you guys commented earlier about L’Orange and diesel was a proxy for all that or not?

Well, L’Orange is usually tied to more longer-cycle industrial. And maybe just a little more clarity on L’Orange. L’Orange as a total business is still doing quite well. We saw over the last 18 months to 24 months, there was a resurgence in the -- if you want to say, the frac-ing market, and we saw lot of rigs needed to be rebuilt. Inventory needed to be replenished, and we saw really strong oil and gas sales, both new, but also in the aftermarket. And that really benefited L’Orange. As we moved into -- for our first quarter here, we were anticipating, but we did see some softness tied also to the oil prices and the point at which is attractive to drill.

And so it was -- we -- call it like a pullback, but pullback is at the reduced drill count, the inventory had been replenished in the distribution channels and so we saw a little 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. But I would say 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 here in the quarter, some of the pre-buy effects, if you recall, from going from China V to China VI emission standards. We started seeing recovery in that. Going forward here, we have a very positive outlook for China VI emission-compliant engines. That's our short -- that's one of the shorter-cycle businesses we have. That every trend is in the right direction except for the Coronavirus. And we really don't know how to forecast or predict what's going to happen there. So short cycle was down a little bit due to those factors. But we'll start recovering. Subject to that, that doesn't become a major issue.

Okay. And then just for clarity, the L'Orange marine aftermarket, you guys have talked about that a lot. Is that still -- how is that doing?

Still doing well.

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 are starting to disclose that in your 10-Qs, I guess, post-ASC 606. I just wondered if that impacted the growth here in the first quarter? Or if it was truly all the IP?

No. It was -- that was basically flat.

(Operator Instructions) Your next question comes from the line of Michael Ciarmoli.

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 the flattish volume from here?

Yes. Well, first, there is the cost containment that I described earlier. But we also have had ongoing productivity improvements around 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 yes, so it's positive that way. And then we're also -- I said, continuing to see good aftermarket. So that plays into it.

Okay. And that's clearly offsetting the excess capacity from pulling out the 300, give or take, units of the MAX?

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

activities to better serve that so.

Got it. Okay. Okay. And then just back to the -- on the free cash flow for year 1 post closing. Can you give us a sense -- I mean, we sort of have a vague road map here of where the 737 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 787 going down to 10? So does that $1 billion become a little bit more challenged, given maybe where that rate is and where the 787 is going?

Well, yes, there's no doubt, rate cuts put some stress on those numbers. But we're committed to delivering those. And we're going to get it to, like you said, that road map of activities. And we'll be anticipating stronger sales throughout the rest of the portfolio as we go into 2021 and onto 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.

It is low 40s or mid-40s at a production rate for the 37 (sic) [737] is that -- I mean, would you articulate what you guys have built into that $1 billion on a rate?

Yes. We had an estimate when we released. Since then, the supply chain from Boeing and the Tier 1s have begun 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 you had.

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

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.

Ladies and gentlemen, that concludes our conference call today. If you would like to listen to a rebroadcast of this conference call, it will be available today at 7:30 p.m. Eastern Standard Time by dialing the number 1 (855) 859-2056 for U.S. or 1 (404) 537-3406 for non-U. S. calls and by entering the access code 7896763. A rebroadcast will be -- will also be available at the company's website, www.woodward.com for 14 days. We thank you for your participation on today's conference call and ask that you please disconnect your line.