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Moog Inc. (MOG.A) (MOG.B) Q2 2021 Earnings Call Transcript | The Motley Fool

Moog Inc. (NYSE:MOG.A) (NYSE:MOG.B)
Q2 2021 Earnings  Call
April 30, 2021, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day. And welcome to the Moog Second Quarter Fiscal Year 2021 Earnings Conference Call. Today’s conference is being recorded.

And at this time, I’d like to turn the call over to Ann Luhr. Please go ahead.

Ann LuhrHead of Investor Relations

Good morning. Before we begin, we call your attention to the fact that we may make forward-looking statements during the course of this conference call. These forward-looking statements are not guarantees of our future performance and are subject to risks, uncertainties and other factors that could cause actual performance to differ materially from such statements. A description of these risks, uncertainties and other factors is contained in our news release of April 30, 2021, our most recent Form 8-K filed on April 30, 2021, and certain of our other public filings with the SEC. We’ve provided some financial schedules to help our listeners better follow along with the prepared comments. For those of you who do not already have the document, a copy of today’s financial presentation is available on our Investor Relations webcast page at www.moog.com. John?

John ScannellChairman & Chief Executive Officer

Thanks, Ann. Good morning. Thanks for joining us. This morning we report on the second quarter of fiscal ’21. Over the last 90 days we’ve become more confidence, the global operating conditions have stabilized to the point where we feel comfortable providing guidance for the second half of the fiscal year.

Overall, it was a very good quarter and we’re optimistic that the remainder of our fiscal year will continue the strong performance. I will follow my usual format today starting with the headlines under the three headings of macroeconomic, microeconomic and most specific items. First in the macro front, we’ve seen a lot of change in the last 90 days. In the US, the new administration is firmly in place in Washington and Federal spending is set to increase dramatically over the next few years as COVID relief infrastructure investments and green initiatives are aggressively pursued.

Eventually, US taxpayers will have to pay for the spending and it now seems inevitable that corporate tax rates are set to increase. The only question is by how much and when. For the coming year the defense budget seems to have averted any major impact but given the defense is a major portion of the federal budget, we assume that longer-term defense spending will be impacted. On the other hand, global tensions continue to similar with China starting to assert itself as equal of the US, Russia threatening the Ukraine and both Iran and North Korea pursuing their nuclear agendas. As such [Phonetic], national security have become intertwined as the US seeks to reestablish a base in critical capabilities, including chip manufacturer and supply chains for the key components of tomorrow’s CleanTech economy. On the COVID front, we’re seeing optimism in the US as vaccinations reach over half of the adult population and the top turns to reopening the economy unfolds. This contrasts with the ongoing challenges in Europe and South America where vaccination rates are much lower and the emerging crisis in Asia, particularly India has new various fuel the next wave of infections. Overall, the global economy is showing signs of renewed strength driving supply chain shortages in critical components particularly electronics.

Second on the bank and the microeconomic front, our major markets are continuing to perform well. Spending on defense and space applications, continues to be robust and we’re starting to see a slow recovery in some of our industrial markets. Commercial air traffic is on an upswing driven by domestic demand. Boeing is ramping up deliveries of the 737 MAX and resumed deliveries of the 787 in the quarter. Production rates at Airbus have stabilized and the aftermarket is much improved from six months ago. Overall a much more encouraging picture than 12 months ago as we had into the pandemic.

Third, it was another good quarter for our business. Total sales were down only 4% relative to a year ago despite an near 40% decline in our commercial book of business. As we discuss our performance relative to the same quarter a year ago. It’s important to keep in mind that our second quarter last year was the last pre COVID quarter we enjoyed.

GAAP earnings per share this quarter were $1.51 and up marginally from the same quarter a year ago but included $0.18 of benefit from the curtailment gain on a foreign pension plan. Absence this gain, adjusted earnings per share of $1.33 with the strongest quarter we’ve had since COVID hit and clearly show the underlying strength of our diverse portfolio of businesses. COVID continues to impact our business globally. But our infections have come down over the last quarter and our operations have continued to perform. We’ve not yet started to bring our folks back into the office, but we’re optimistic that this will start to happen in select geographies as we enter our fourth quarter.

Cash flow in the quarter was soft after a blowout first quarter despite the soft second quarter year-to-date, we’re still running a healthy conversion ratio of over 90%. Looking at our key markets defense and space continued strong, industrial is showing early signs of recovery commercial is stable and medical is solid, but coming off a surge in COVID related demand over the last year. Our supply chains continue to function well, although the emerging component shortages in the industrial markets are a watch item for the coming quarters.

Finally on February 18 our Space team celebrated the successful landing of the Perseverance rover on the surface of Mars. The multi-provided valves which measured the flow of fuel to the descent rocket motors. We use the phrase when performance really matters to illustrate the critical nature of the applications, which use our products. Ensuring a safe landing on the surface of Mars after a 7-month 350 million-mile journey is the perfect example of when performance really matters. My congratulations to all our team members who contributed to this technological wonder.

Now let me move to the details, starting with the first quarter results. Sales in the quarter of $736 million or 4% lower than last year similar to the story for the last four quarters, sales were up in defense, space and medical down slightly in Industrial and significantly lower in commercial. Taking a look at the P&L, gross margin was in-line while R&D was up slightly, partly driven by the Genesis acquisition.

SG&A was down on a dollar basis, but up marginally, as a percentage of sales. Interest expenses in line. We had a one-time $6 million gain in the other line associated with the pension curtailment in the foreign plan which Jennifer will explain in more detail. The effective tax rate this quarter was 21.6%, resulting in net income of $49 million down 2% from last year and earnings per share of $1.51 up 2% from last year on a lower share count. Fiscal 21 outlook we continue to assume that COVID will be a major factor, through the end of this fiscal year and are planning accordingly. We believe the second half will be very similar to the first both in terms of sales by market and underlying earnings. I’ll provide more details in the roundup for each segment.

Taken altogether, we are expecting full year sales of $2.84 billion and full-year earnings per share of $5 plus or minus $0.20. Sales in the segment, I will remind our listeners that we provided a three-page supplemental data package posted on our webcast sites, which provides all the detailed numbers for your models. We suggest you follow this in parallel with the text.

Beginning with aircraft, sales in the second quarter of $304 million were 11% lower than last year. The pattern of the past year, continued with strong military sales compensating for lower commercial sales. Preparing with the same quarter last year military OEM and sales were up a third and increased funded development work and higher equity prices. We also booked $8 million in sales from our Genesis acquisition which completed at the end of December. In contrast to the OEM, the military aftermarket was down 20% from a very strong Q2 last year. The softness was a combination of some delayed shipments at the end of the quarter combined with a more general slowdown across a broad range of programs. It’s too early to tell if this is a trend or just a natural fluctuation of the business on a quarterly basis.

On the commercial side, OEM sales were down almost 40% from a year ago with continued weakness across the complete portfolio. Sales on our two largest programs 787 and the A350 were both down over 40% but sales in business jets, were down almost 50%. Commercial aftermarket was down 34%. On a sequential basis Q2 shows some encouraging signs over the first quarter. Military sales remain strong; will be a down slightly from the first quarter on lower aftermarket sales. Commercial OEM sales showed nice improvement across almost the entire portfolio as production rates stabilized and Boeing deliveries of 787 resumed.

Because commercial aftermarket was also up as domestic flight operations continue to improve. Aircraft margins, margins in the quarter were 7.2% in reviewing the margin performance this quarter three comparisons tell the story. First as expected, margins were down from Q2 fiscal ’20 of the lower commercial sales. Second, also as expected margins were down sequentially from our first quarter. 90 days ago, we explained that we had an unusually favorable mix in the first quarter and we’re anticipating lower margins in subsequent quarters. Third and most important, margins were up significantly from the adjusted run rate of 3.5% in the second half of fiscal ’20. This improvement in the underlying business is a result of the continued strength in the military book, the firming demand in the commercial book and the actions we took last year to resize the business.

Aircraft fiscal ’21. We’re projecting the second half of our fiscal year would be very similar to the first. Sales into the military markets will remain strong with OEM sales in the second half marginally, lower than the first half with aftermarket sales marginally higher. On the commercial side, the production rates on the major programs have now settled and will probably remain stable well into next year.

In the aftermarket global flight operations continue to pick up, but we believe we’ve already seen this benefits flow through in our first half as sales increased almost 20% from the run rate of the previous six months. Taken altogether, we’re forecasting the second half in commercial in line with the first half. The net result is full year sales of $1.18 billion, including $40 million from the Genesis acquisition we closed in December. This total is down just 2% from fiscal ’20 sales. Second half margins will be approximately 8%, bringing full-year margins to 8.2%.

Turning now to Space and Defense. Sales in the second quarter of $206 million were 7% higher than last year based the new business continues to drive the growth with sales up 19% from a year ago. We have continued strength in our NASA work as well as growth in our integrated space Vehicles product line. Over the last decade we’ve strengthened our component offerings and wants to combine these components into integrated space vehicles. Our orbiting maneuvering vehicle or OMV was the first product of this effort and over the last couple of years we’ve continued to broaden that offering to include small satellite buses. The boom with low cost satellites and the availability of cost effective launch capability is now fueling our growth in this business. The defense markets were in line with last year with some shifts in the mix. The other components on military vehicles were up, as were sales into naval applications.

These increases were offset by lower sales of fin-steering systems for tactical missiles and into security applications. Margins in the quarter were 12.9%, this margin performance is particularly strong given the high proportion of funded development work in this business combined with the challenges of COVID, base in the sense, fiscal ’21. We’re protecting full year sales of $795 million. We believe both the space and defense businesses will remain strong and will each have failed in the second half, pretty much in line with the first half. Full year margins will be 12.3%.

Turning now to our Industrial Systems business. Sales in the second quarter of $226 million were marginally lower than last year. Adjusting for foreign exchange movements real sales were down over 5%. Sales were lower in our energy and simulation test markets. Compared to last year energy sales were adversely impacted by delays in various exploration projects. On a more positive note, the run rate for energy sales has been fairly stable over the last few quarters and we are seeing signs of modest growth going forward.

Sales of motion basis for full-flight simulators were down over 50% from the same quarter a year ago as the demand for additional simulator capacity has plummeted. We have the product into Industrial Automation were in line with last year after adjusting for Forex, on a positive note, sales into industrial automation up sequentially in the last three quarters indicating that this market is starting to strengthen.

Sales into the medical market were up 7% from a year ago and in line with our first quarter. Margins in the quarter were 10.5%, margins in this business are starting to improve as we see the first signs of recovery particularly in the industrial automation market. Industrial Systems fiscal ’21, for the full year, we’re projecting sales of $865 million similar to our other two groups. This assumes a second half total in line with the first half. We will however have some slight changes in the mix comparing the next six months to the last six months. We think sales into the energy and industrial automation markets will strengthen marginally. Sales into simulation and test will be flat and sales into medical markets would be down slightly.

The slowdown in our medical markets it’s caused by the reduced need for COVID related equipment, which drove a spike in our pump demand over the last 12 months. We’re projecting full year margins of 10% in line with the first half, these margins are down slightly from the second quarter as a result of additional organic investments, we’re planning to make in emerging opportunities in the industrial approach electric vehicle market.

Summary guidance we’re pleased with our performance in the first half of the year and are looking forward to repeating that performance in the second half. Our business continue to operate effectively despite the ongoing imposition of COVID restrictions. Over 60% of our businesses in the US ends with vaccines now widely available. We’re hopeful that our fourth quarter could be the starting to transition back to a low a more normal work environment.

Our operations in Europe and in some Asian countries are probably a quarter or more behind the schedule but we’re optimistic that our fiscal ’22 will be the start of the post-pandemic era. Market diversity and financial prudence have guided us through the pandemic. And we continue to be the core of our business going forward. Our capital allocation strategy is unchanged, we look to invest in growth and return excess capital to shareholders through our dividend and buyback. As we emerge from the pandemic, we’re seeing increasing opportunities to invest in organic growth. The combination of capital expenditures and R&D. We also continue to be active in the M&A market but with best [Phonetic] almost free and excess capital looking for a home, prices remain at levels we find unattractive.

We will continue to search, but will remain both patients and prudent. As we look at the second half of the year we are reinstating guidance after 12 month hiatus. We believe the second half. Pretty much mirror the first is that we give full year sales of $2.84 billion and full-year earnings per share of $5 plus or minus $0.20. For the third quarter, we anticipate earnings per share of $1.16 plus or minus $0.15.

Now, let me pass it to Jennifer who will provide more color on our cash flow and balance sheet.

Jennifer WalterVice President & Chief Financial Officer

Thank you, John. Good morning, everyone. Free cash flow in the second quarter was $6 million compared to $12 million in the same period a year ago. This follows a very strong first quarter and brings our year-to-date free cash flow conversion to just over 90%. The moderation in our cash flows this quarter resulted from slower collections on receivables shipments late in the quarter and increased investments in capital expenditures.

The second quarter marked the turning point in our inventories, which were a source of cash for the first time since 2018. The substantial amount of effort and focus of our teams across the company and most notably in our aircraft operations resulted in this achievement. Efficiencies associated with operations 2.0 are beginning to be realized as we also continue to focus on optimizing incoming receipts. The $6 million of free cash flow in Q2 compared with an increase in our net debt of $9 million. During the second quarter, we paid our quarterly dividend and repurchased just under 100,000 shares of our stock for $7 million. Year-to-date we acquired about 250,000 shares for $17 million.

Net working capital, excluding cash and debt as a percentage of sales at the end of Q2 was 30.5% compared to 29.2% a quarter ago. Receivables grew during the quarter as key customers in our commercial aircraft business both came at quarter end. Receivables also increased due to the timing of industrial shipments which were unusually strong late in the quarter. Net increase in customer advances partially offset the growth in receivables. Capital expenditures in the second quarter were $38 million, up sharply from $20 million in the first quarter. We started to catch up on capital investments that we had delayed during the more uncertain times of pandemic. We are also investing in our operations to achieve greater efficiencies in our facilities to support our business.

At quarter end, our net debt was $878 million including $91 million of cash. The major components of our debt were $500 million of senior notes, $396 million of borrowings on our US revolving credit facilities and $69 million outstanding on our securitization facility. We have $670 million of unused borrowing capacity on our US revolving credit facility. Our ability to draw on the unused balance is limited by our leverage covenant, which is a maximum of 4.0 times on net debt basis. Based on our leverage, we could have incurred an additional $427 million of net debt as at the end of our second quarter. We are confident that our existing facilities provide us with the flexibility to invest in our future.

Cash contributions to our global retirement plan totaled $14 million in the quarter compared to $12 million in the second quarter of 2020. Global retirement plan expense in the second quarter of $13 million, down from $20 million in the second quarter of 2020. The decrease in expense is attributable to a $6 million curtailment gain associated with terminating our defined benefit pension plan in the Netherlands. We replaced this plan with the defined contribution plan and this change benefit of both the company and the plan participants. The gain is recorded in the non-service pension line. The financial impact resulted from participants transitioning from active status in the plan to deferred participant data and the related projected benefit obligation decreased due to these participants becoming inactive. The curtailment gain increased our earnings per share by $0.18.

Our effective tax rate was 21% in the second quarter compared to 19.2% in the same period a year ago. We benefit in each of these periods. In the second quarter of 2021, there was no tax expense associated with the curtailment gain on the termination of the Netherlands defined benefit pension plan, thereby lowering the effective tax rate. Last year’s second quarter rate reflects the reduction in cash rate related to taxes accrued on accumulated earnings and one of our foreign jurisdictions as well as reduced withholding taxes previously accrued and another foreign jurisdiction.

We expect free cash flow generation in 2021 to be in line with our long-term target of 100% conversion. Excluding the non-cash gain from the pension curtailment we were at that level in the first half of this year. In the back half of the year, we expect cash flow generation from working capital. Inventories will contribute to cash inflows probably worked down customers advances.

Capital expenditures will continue to be elevated as we invest in some facilities to support future growth and consolidate other facilities as we refine our footprint. We expect 2021, capital expenditures to be $140 million and depreciation and amortization to be $91 million. We are well positioned to invest in our organic growth and our finding this to be an attractive opportunity and deploying our capital. We continue to explore opportunities to make strategic acquisitions, and return capital to shareholders.

12 months ago we are facing great uncertainties in our business. We came into the early days of the pandemic having recently refinanced our debt positioning us nicely coming into the challenging business environment. We responded by conserving our cash and preserving our liquidity, as well as managing expenses and certain investments. Our approach has paid off and shows in our leverage ratio. Our leverage ratio was 2.7 times on a net debt basis, as of the end of the second quarter compared to 0.6 times a year ago. This slightly higher ratio reflects the pressures on EBITDA from the impacts of the pandemic over the last 12 months and our acquisition of Genesis offset by very strong cash flow generation during the period. Our current leverage ratio continues to be within our target zone of two in a quarter times to two in three quarter time.

With that I will turn it back to John for any questions you may have. John?

John ScannellChairman & Chief Executive Officer

Thanks, Jennifer. And Nick, we would like to open the line for questions, please.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Cai von Rumohr with Cowen. Please go ahead.

Cai von RumohrCowen & Company — Analyst

Yes, good quarter. John. Nice work. So commercial, you mentioned the commercial aircraft numbers while they were down. They look certainly better than we’d indicated, we’ve guessed. What was making it up, I mean was it the normal Airbus and Boeing deliveries 787 and A350, or was it other because they looked at a little stronger than I would have guess.

John ScannellChairman & Chief Executive Officer

So a couple of things, Cai. One of the things about our commercial business is that it’s so hard to factor in the impact of inventory coming in, it’s like this because it’s long-term contract accounting. So it’s not based on shipments and that’s the sales are driven a lot by incoming inventory, of course orders from our customers. Couple of things happened, though, if you look at the Airbus sales that we had a couple of quarters ago they were doing enormous destocking and while the headline number was that Airbus went from 10350 to 530s we were shipping almost no product for a quarter or two. And so that’s now stabilized. And I think to some extent that’s happened is going as well. So there has been some of that destocking has kind of washed through and we now feel that we’re at a pretty stable production rate. But as a result we’ve seen sequentially. Our commercial OE business picks up over the last few quarters because of that.

Then we have the fact that orders have been pushed out, but nonetheless we still have open orders and as we get inventory in which we’d be working real hard to slow but that inventory gets takes the orders and so you actually take sales on that as you go through the system. So there’s a lot of moving pieces over the last several quarters that make it difficult to extract some kind of a conclusion from our actual sales number in one quarter versus the past. What I would say is that we believe now that inventory destocking at the primes has washed through. We believe that our incoming inventory is now much better matched to the demand going forward. And we believe that the rates are relatively stable and that’s why we think our second half will kind of line up pretty much with what we saw in the first half.

Cai von RumohrCowen & Company — Analyst

That’s very helpful. And then you have very strong military aircraft sales. And you mentioned you know the development work is that development work on one program or several programs?

John ScannellChairman & Chief Executive Officer

So that’s a broad range of programs, Cai. And it’s one of the things I emphasize that I think it’s important that we have a concern I think everybody in the defense business has that if you move out a few years defense spending is highly likely to be pressure just given the amount of government spending that’s going on, but on the other hand, the only. I think the only indicator of the future is how much development work, how much are we working on the future programs and that’s very strong. It’s now running well north of $100 million this year and if we go back four, five years; it was $20 million business, so we have won a lot of positions on new programs. Most of that we can talk about, I don’t know how many of them will to big production programs in the future, but it is a positive sign. So that is very strong and it’s up from what we thought entering the year by couple of $10 million to $15 million, $20 million. Just given the strength of some of the programs that we’ve won and the opportunities we’re seeing.

Cai von RumohrCowen & Company — Analyst

And then the last one for me is space, you continue to deliver these very, very strong numbers. Your full year guide kind of implies, you’re going to slow down in the second half, which I think is what you were kind of saying last year and you didn’t. Could you give us some color in terms of what is driving this very, very good growth? And what’s the potential that may be the second half is a little better than you’re projecting?

John ScannellChairman & Chief Executive Officer

So the growth has been driven by a couple of things, Cai. We got, we’ve kind of mentioned them over the last year or two; one, NASA has just got a lot more work on NASA on FLS systems; so we’ve really benefited from that. The hypersonics as we mentioned, we called hypersonics into two areas; the fin-steering is in our defense side and the large stuff we put on the space side. So that’s been a obviously has been a lot of work in that. And then the third piece is what we’re calling space vehicles and this is where we’ve been working over the years to kind of pull our components together and offer more of a small satellite, but, and we’re seeing some nice opportunities in that and some growth in that side of the business.

Could the second half to be better than the first? Perhaps, but I would also caution that you can keep growing at in 19% to 20% per quarter on the not going basis forever. And so what is starting to happen is, we’re just seeing that level up, I mean it’s a tremendous business it’s double what it was just a few years ago, but that heavy growth is just not going to be something that we’re going to continue to see indefinitely. So I was wrong last year. Maybe I’ll be right this year. It’s our upside. Yes. But I’d be cautious about getting ahead of it.

Cai von RumohrCowen & Company — Analyst

Terrific, thank you very much.

Operator

Thank you. And our next question comes from Ken Herbert with Canaccord. Please go ahead.

Ken HerbertCanaccord Genuity — Analyst

Hey, good morning, John and Jennifer. Hey, John, I guess I just wanted to follow up on your comments on the military aircraft market. When I look at the second half implied numbers, it looks like you’re seeing, you’re seeing some nice growth, high single-digits in the business. But you’re looking for better high-teens growth on the OEM side with aftermarket down on the military side. And I know you made some comments earlier about, it’s a little early to draw aftermarket military trends, but I wonder if you could flush that out a little bit. I know you’ve got some tough comps there, but how should we think about the military aircraft business in the second half and what are some of the key puts and takes in that business?

John ScannellChairman & Chief Executive Officer

What we’re picturing is that we think the second half will be similar to the first on the total. If you look at the run rate of the first half and you just double that, it’s pretty much what we’re seeing. But we believe that the OE side will be down a little bit and the aftermarket side will be up. Let me do this, Ken. If I go back to 2019, our OE side was about just $415 million. Last year our OE was $470 million and this year, we’re forecasting the OE at $580 million. With this put into context, it is up significantly from what we saw a year ago, it’s up over 20% from what we saw last fiscal year. We had incredibly strong first and second quarters. Our F35 business has been particularly strong. As I mentioned earlier, you’ve got to keep in mind that some of that has to do with how inventory comes in and it’s not just all shipments. We think that’s been very strong, we think it will continue to be strong. We’ve seen the — it’s under development, as I mentioned, it’s high improved significantly over the last year, but in terms of taking a step back, rather than just saying, let me look at the second quarter and annualize that. Look at fiscal 20, $470, fiscal 21, $580 on the OE side and that’s a significant pickup. Major drivers are at fund the development, and keep in mind, we also have $40 million of Genesis in there; so that contributes there.

If I do the same for the aftermarket side, if I go back to 2019 and for last pre COVID year, $207 million. Last year, we did $250 million in the military aftermarket. So that was really a blowout year and this year, we’re now forecasting $240. So, it’s still up nicely from 2019, up a little bit from 2020, but it’s still a really strong year. That’s up from the run rate in the first half. We think the first half was depressed a little bit, particularly the second quarter, we had some shipments that didn’t go out and then there was a little bit of softness in the business. We’re anticipating it will get better as we go through the second half. We see a pickup in the second half. The story for the second half, you put it together. It’s kind of flat for the total, but the OE side will be up a bit. Coming off of a very strong first half, but still much better than last year and the military aftermarket would be up from the first half, but down from what we got from a very strong last year. So, little bit of a mix shift there, but overall, I think it’s still very strong performance. You just have to take a little bit of a step back and look at a longer time period.

Ken HerbertCanaccord Genuity — Analyst

That’s very helpful. As we think for the military aircraft business sequentially from the first half to the second half in 2021, shouldn’t the better aftermarket sales and the growth sequentially relative to some of the OE sales down, perhaps drive better margins since you see some more mixed benefit than perhaps the guidance implies in the second half of the year?

John ScannellChairman & Chief Executive Officer

If we do the margins in the aircraft business, we had very strong first quarter margins, which we had mentioned last quarter, that’s not going to be sustainable for the long term, they were in the mid ’90s. We just did a margin of 7.2 in the second quarter, which I would say would be more in line with the business and we’re forecasting H2 for the year. So, we’re forecasting the second half margins will be about 8%. There’ll be up from a second quarter of 7.2%, but down from, as I said, a very unusual first quarter. Actually, yes, the margins are up on a slightly improved mix as you point out. The aftermarket would be more of a contributor. They’ll be up from 7% to about 8% in the second half. The other comparison, I think is really helpful, is if you look at the second half of last fiscal year. This is the 6 months of COVID that we suffered, and you adjust for some of the significant restructuring we did, underlying margins were about 3.5%, we still have a book of business, where our commercial is way down, military is really strong. But those underlying margins have gone from 3.5% over the last 6 months of last year to what we’re saying is going to be north of 8% for this year and I think that’s a significant improvement in the business. Yeah margins would be up a little bit from the second quarter, but down from the first on a kind of an unusual mix.

Ken HerbertCanaccord Genuity — Analyst

That’s great. Just one final question for Jennifer. The free cash flow continues to be very strong and I think you’re talking about 100% conversion for the full year. As you look into the second half of the year, I know you’ve gone through some of the pieces of working capital, but where could we see upside again on the free cash flow? Is there more in working capital you can do on inventory in particular than what you’ve called out?

Jennifer WalterVice President & Chief Financial Officer

I mentioned in the prepared remarks, the inventory in the first time that we’ve had a positive inflow of cash related to inventory. We are projecting for the next couple of quarters to also have contributions from our inventory being a source of cash. We don’t want to get ahead of ourselves to say how quickly that can ramp up, but we’re certainly feeling good that we’ve been able to turn that corner as well. When I look at some of the other pieces in there, we’ve had really strong customer advances the last couple of quarters and certainly we’re going to be needing to work that down over the next couple of quarters. So, we’re going to see some pressure on there and feeling like we’re in a pretty balanced position as we’re looking at that, especially considering the investments that we’re pursuing related to our capital expenditures that’s going to offset some of the generation from the working capital.

Ken HerbertCanaccord Genuity — Analyst

Okay, great. Thank you very much. Nice quarter.

Operator

Thank you. Once again, if you’d like to ask a question, please press Star-1. We’ll take our next question from Michael Ciarmoli with Truist Securities. Please go ahead, sir.

Michael CiarmoliTruist Securities — Analyst

Hey, good morning, John and Jennifer. Thanks for taking the questions here. Nice results. Maybe, I don’t know who wants to take this, I guess, John. How should we think about the margin expansion journey and I guess I’ll start in aircraft, you’re certainly doing very well now and you just talked about a second-half run rate of 8%, you’re still dealing with lower volumes, you’ve got the benefits of operation 2.0 and I’m assuming, you’ve still got higher margin provisioning volumes that are still going to be way down. I’m not going to ask you for guidance next year, but it seems like exiting at 8% should be definitely a new floor and it would seem like as the volumes come back, you get some more of the efficiency benefits with operation 2.0 and even provisioning volumes, it should seem like you’ve got a good trajectory here for margin expansion. Any kind of thoughts on how we should think about this going forward?

John ScannellChairman & Chief Executive Officer

Yeah, I think your thesis makes sense, Mike, but we’ve seen some nice improvement, as I’ve said, from the second-half run rate to the first half of this year and what’s come through in the course the benefit of the restructuring that we’ve done and the continuing the continuing focus on efficiency improvements and so. We still continue to see some marginal gains from that I think as we go out over the next couple of years, but the real gain is when you start to get those volumes back up both on the commercial aftermarket and on the OE side. Looking out at the moment, it’s not clear that Boeing and Airbus are going to be ramping up their A7 and 350 rates anytime soon. The aftermarket should continue to come back. That would be good. If they started flying particularly the international routes, but also looks like that could still be ways away. So, yes, if we could see the commercial book continue to improve, we continue to see that margin expansion. Military stuff is very strong. If that continues, we’ll continue to enjoy that and our operational activities continue to show some benefit, but I think the real catalyst from here on out, our commercial book is still 40% down on what it was a year ago. If we could see that come back, we’d start to enjoy much better margin performance.

Michael CiarmoliTruist Securities — Analyst

Got it. Jennifer, you were just talking about inventory being a tailwind cash and John just said you don’t know when those widebody rates are going to come back, but how are you thinking about your inventory levels. We’ve already been hearing from some management teams thinking about potential tightness in the supply chain. If there is a potential big ramp back up to those production rates. As you evaluate your suppliers and think about inventory levels, do you feel comfortable with the ability to ramp back up and that you’ll have access to your raw material?

Jennifer WalterVice President & Chief Financial Officer

Yeah, that’s a good question and certainly an area that has gotten more attention in the news. We have been paying more attention to it because of the discussion with what’s happening in automotive and those types of areas right now. We are closely monitoring that, so that we will mitigate the risk associated with any supply chain disruptions. But we feel like we’re in reasonable shape and making sure that we’re managing inventories to appropriate level while also trying to manage that risk.

John ScannellChairman & Chief Executive Officer

Yeah, I can’t imagine, Mike, that we’re going to go back to build ten 787s a month overnight. I’d be delighted if we have that problem to [indecipherable]. But it feels to me like the acceleration of the ramp up. My concern always in the aircraft business is not the ramp-up, it’s always the ramp down. Because the ramp down happens overnight. We just saw that in the last 12 months. Typically, the ramp ups are pretty well planned and can be scheduled out. We would be happy to have that problem. We’ve got plenty of inventory at the moment. I think we’re feeling pretty good about any ramp up.

Michael CiarmoliTruist Securities — Analyst

Got it. Just on that ramp down you mentioned, are you guys still dealing with or struggling with a lot of excess capacity costs? Have you been able to reallocate to other military programs or how much of a drag is sort of excess unallocated overhead to the aircraft margins right now?

John ScannellChairman & Chief Executive Officer

We did a significant resizing. We actually ended up doing a couple of times, Mike, as much as we didn’t want to through the end of last calendar year. That’s all behind us in terms of the staffing levels. We took some significant writedowns as well as some equipment and facilities if you remember at the end of 4th quarter particular last year. However, you still end up carrying if you think it’s just the organization you need. The fact that you’re buying instead of buying 10 you’re buying 5 [Phonetic]; you still have the same number suppliers, the same number of inspections etcetera. There is over excess overhead relative to the size of the business. In other words, as you scale up, you get more efficiencies out of that. I wouldn’t pull that figure out right now. As I said, we’ve tried to cut to the level that we think it’s sustainable. But there’s no doubt if rates start to go up, we would start to see nice incremental margins from there, but there is a bit of pressure on that in terms of having less than fully utilized facilities and probably carrying more of the overhead side based on a larger organization, which is what we need it before.

Michael CiarmoliTruist Securities — Analyst

Perfect. Thanks guys.

Operator

Final reminder to our audience, you may ask a question by pressing star one now. It appears that we have no additional questions at this time.

John ScannellChairman & Chief Executive Officer

Thank you very much indeed for your help. Thank you all for listening in. We hope everybody remains safe. I hope, like us, everybody is starting to think about how do we start to get back to a more normal lifestyle and we look forward to coming back to you in 90 days’ time. Thank you.

Operator

[Operator Closing Remarks]

Duration: 42 minutes

Call participants:

Ann LuhrHead of Investor Relations

John ScannellChairman & Chief Executive Officer

Jennifer WalterVice President & Chief Financial Officer

Cai von RumohrCowen & Company — Analyst

Ken HerbertCanaccord Genuity — Analyst

Michael CiarmoliTruist Securities — Analyst

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