Hexcel Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 18, 2024

There are 15 speakers on the call.

Operator

Thank you for standing by, and welcome to the Hexcel Second Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer Thank you. I'd now like to turn the call over to Patrick Winterlech, Chief Financial Officer. You may begin.

Speaker 1

Thank you, Rob. Good morning, everyone. Welcome to Hexcel Corporation's Q2 2024 Earnings Conference Call. Before beginning, let me cover the formalities. I want to remind everyone about the Safe Harbor provisions related to any forward looking statements we may make during the course of this call.

Speaker 1

Certain statements contained in this call may constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward looking statements today. Such factors are detailed in the company's SEC filings and earnings release. A replay of this call will be available on the Investor Relations page of our website. Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material.

Speaker 1

It cannot be recorded or rebroadcast without our express permission. Your participation on this call constitutes your consent to that request. With me today are Tom Gentile, our CEO and President and Kurt Goddard, our Vice President of Investor Relations. Purpose of the call is to review our Q2 2024 results detailed in our news release issued earlier this morning. Now let me turn the call over to Tom.

Speaker 2

Thanks, Patrick. Good morning, everyone, and thank you for joining us today as we share our 2024 Second Quarter results. I'm excited to be succeeding Nick Stanage as CEO and President of Hexcel and participating in my first Hexcel earnings call. Nick had a very strong tenure as CEO over the last 10 years and positioned the company for future leadership. The strong financial results this quarter reflect the efforts the Hexcel team has made over the last several years to recover from the pandemic.

Speaker 2

As you read in our news release earlier this morning, Hexcel's 2nd quarter sales of $500,000,000 were up more than 10% year over year on strong performance, especially so in commercial aerospace where sales grew more than 21% year over year. At $0.60 our EPS was 20% better than Q2 2023. As a side note, the last time Hextel quarterly sales exceeded $500,000,000 was the Q1 of 2020. As we look ahead to the second half of twenty twenty four, some of our commercial aerospace customers are flagging continued challenges in the aerospace supply chain and slowing previously communicated production rate increases. Notably, on June 24, Airbus signals a reduction in deliveries for 2024 from 800 to 770 aircraft, indicating it would impact all programs, including importantly for Hexcel, the A350, which is our largest individual program.

Speaker 2

Boeing deliveries have also been below plan for the first half of the year. Our initial 2024 guidance was based on sales from Airbus and Boeing continuing to grow throughout the year. That now appears to be less likely. And we expect sales and earnings in the second half of twenty twenty four to be generally similar to the first half of the year. We have therefore revised our guidance for 2024 accordingly based on a more cautious near term outlook.

Speaker 2

Our revised guidance is as follows: sales of $1,900,000,000 to $1,980,000,000 previously it was $1,925,000,000 to 2,025,000,000 dollars Adjusted diluted earnings per share of $2.02 to $2.18 previously $2.10 to 2.30 dollars and free cash flow of around $200,000,000 previously greater than $200,000,000 We feel this revised guidance is a more prudent reflection of the softer market conditions for commercial aircraft production that we now expect in the second half of twenty twenty four. With that said, we remain confident in the mid term outlook for commercial aircraft and expect both Airbus and Boeing to continue to increase their production rates over the coming years. For example, Airbus has announced that the A350 will be reaching 12 aircraft per month by 2028. We are therefore not making any changes to the midterm guidance previously shared by the company at our February Investor Day and reconfirmed at the beginning of May. Underpinning our confidence in the mid term outlook is the increased demand for new lightweight aircraft with around 14,700 aircraft now in backlog for Airbus and Boeing combined.

Speaker 2

Total revenue Passenger Kilometers or RPK continues to grow with the EADA reporting record international passenger traffic. Domestically, the TSA reported a record level of security screenings earlier this month. This strong air traffic and healthy backlog is driving a recovery in aircraft production rates, which should get us back to 2019 production levels during 2026. The outlook for commercial aerospace production in the midterm and beyond is tremendous and Hexcel is well positioned to benefit as the aerospace supply chain continues to recover. Lightweight Hexcel advanced composite materials will enable enhanced sustainability and efficiency for decades to come as lighter aircraft and more aerodynamic architectures extend range, reduce fuel consumption and drive lower emissions.

Speaker 2

This compelling lightweight value proposition is one of the things that attracted me to Hexcel and it will become even more powerful over time as the aerospace industry focuses more on emissions reduction and sustainable aviation. Every generation of aircraft over the last 30 years has used more advanced composite materials than the last. Advanced composites now represent more than 50% of the weight of both the A350 and the 787. We expect this trend to continue. I began my tenure as CEO at Hexcel about 11 weeks ago and my initial priority has been visiting our sites to meet and listen to our employees and learn more about the operations, our innovation agenda and the lightweight material solutions we provide that are so critical to current and future aerospace and defense programs.

Speaker 2

At my previous company, I was a significant user of Advanced Composites to make airframe and engine parts and structures. And now I have the opportunity to learn in-depth how these amazing materials are developed and produced. Hexcel is a highly technical advanced composite materials company with very high barriers to entry, making Hexcel an important partner to commercial and defense customers. Only a few companies make the premium carbon fibers and lightweight composite materials required by the aerospace and defense industry. And Hexcel has the largest and broadest portfolio of these products.

Speaker 2

Hexcel has 22 manufacturing sites and so far I have visited 12 of them in the U. S, Europe and Morocco. I've met hundreds of employees and have had the opportunity to learn more about Hexcel's manufacturing value chain in-depth, starting with precursor to producing carbon fiber to weaving, to pre prepreg and then both honeycomb and engineered core. Just as importantly, I've had the opportunity to see firsthand how the 1 Hexcel culture ensures that these products are manufactured in one of the safest workplace environments that have ever experienced. The foundation of the Hexcel culture is worker safety.

Speaker 2

All meetings begin with a safety message. Our teams constantly reinforce safety practices in a positive manner. Our Hexcel performance metrics for operation management incorporate safety metrics and so many employees I have met have told me how committed they are not only to their own safety but also to the safety of those around them. In addition to safety, I saw firsthand the commitment this team has to operational excellence with a very strong emphasis on quality. In our continuous process flow production system, we are literally conducting testing on batches of products 20 fourseven.

Speaker 2

This commitment to safety and operational excellence has resulted in a continual focus for on time delivery to ensure that HEXO is never the weak link in the supply chain. I've been very pleased to see that we have the capacity in place and the staffing in our factories to meet all of our customers' near term requirements. Our new staff have received their training and are getting now valuable on the job experience as production rates and efficiency continue to recover. I've also spent time at a number of our research and technology centers of excellence, meeting with our scientists and better understanding the lightweighting solutions being developed for next generation applications. This is truly leading edge material science technology and we are continually working closely with many of our customers on the material systems for next generation programs.

Speaker 2

Even though the launch and entry into service of some of these products might be years into the future, the discussions on material systems are happening right now. Besides site visits, I participated in Hexcel's annual management development review, enabling me to quickly get up to speed with understanding the strengths of the Hexcel team. This was followed by the annual Hexcel strategic plan meeting or STRAP as we call it. STRAP is primarily focused on the next 5 years, but also encompasses a 10 year strategic view of the aerospace cycle ahead. It is about how we execute on our commitments, how we innovate to ensure we lead the world in advanced composite technology and how we identify the best opportunities to grow our business.

Speaker 2

In other words, it's all about how we win, how we build on what is working and how we continue to strengthen our engagement with our customers. STRAP is based on a multiyear planning horizon using a very comprehensive bottoms up forecasting process. Hearing from our global leaders makes me more convinced than ever that modern commercial and defense aircraft and the potential for 0 emissions aviation will utilize increasing quantities of the lightweight deposit materials that Hexcel provides. And because of that, our market opportunities are compelling. As CEO, I intend to reinforce and optimize Hexcel's existing strategy.

Speaker 2

We are a global technology leader in advanced material composites with an unrivaled lightweighting product portfolio, especially for aerospace applications. We focus on innovation and we benefit from a global scale along with deep customer relationships. We target markets undergoing secular growth where we can benefit from a sustainable competitive advantage. We are in sole source positions by developing leading edge solutions and delivering quality products on time. And we do this by focusing on our talented employees, a team that is highly experienced, engaged and committed to what they do.

Speaker 2

In addition to meeting with employees, I also met with many of you in our investor community in recent weeks at analyst conferences and individual investor meetings. We have had engaging conversations and I look forward to continuing that dialogue. In addition, I have of course been active in reconnecting with many of HEXO's customers in my new capacity. While I was in France last month, I had the opportunity to meet with Safran and attend the 50th anniversary celebration for CFM, which is the partnership between Safran and GE that produces the LEAF engines for the 7 37 MAX and the A320neo. CFM is extremely successful in a case study on partnerships.

Speaker 2

At that event, I also met with key leaders for many of our other customers. And finally, I am flying to Farnborough tomorrow have a full schedule of customer meetings in the coming days at the air show. Now let me take a moment to share a couple of more highlights that are related directly to Hexcel. First, in the area of sustainability. Hexcel established a relationship with a composite material recycler called FairMat almost 3 years ago to recycle carbon fiber pre frac from our European operations.

Speaker 2

In May, we announced yet another agreement with FairMat, this time in the U. S. It's a 10 year agreement to recycle carbon fiber composite materials from Hexcel Salt Lake City for reuse in composite materials sold into various commercial markets. Our continued partnership with FairMat further demonstrates our dedication to reduce landfill waste, which is part of our 2,030 sustainability targets. 2nd, we were pleased to host Utah State Governor Spencer Cox and others at our Salt Lake City site as Project Alta was announced.

Speaker 2

This project is a coalition of industry leaders, policymakers and community members working together to build a safe and collaborative future through advanced air mobility. XL remains at the forefront of material science to support the development of electric vertical takeoff and landing aircraft for use in advanced urban air mobility networks. This is thanks to our advanced lightweight composite materials that will help make energy efficient, reliable and cost competitive air vehicles a reality. Finally, let me take a moment to reiterate a point from our earnings release earlier this morning, and that is capital allocation and specifically our share repurchases. In the Q2 of 2024, we repurchased around $100,000,000 of Hexcel stock.

Speaker 2

And in the Q1, we had done the same, bringing the total repurchases to just over $200,000,000 this year as we see value in Hexcel stock and returning excess cash to our shareholders. As we continue to recover back to 2019 levels of production, we will generate more cash. Our capital allocation will be first to fund execution on our current customer commitments, drive productivity in our factories and continue innovating to position Hexcel to provide the material systems and solutions on next generation platforms. We have a lot of organic growth potential. We will also look in a disciplined way at inorganic material science growth opportunities that meet our strategic and return thresholds and strengthen our competitive technology portfolio.

Speaker 2

But if the right opportunities do not materialize, we will continue to pay a dividend and review opportunities for future share repurchases. We currently have remaining authorization of $285,000,000 Now let me turn it over to Patrick to provide more details on the numbers. Patrick? Thank you, Tom.

Speaker 1

As a reminder, regarding foreign exchange exposure and I've explained in detail during previous earnings calls, Hexcel benefits from a strong dollar. We continue to hedge foreign exchange exposure over a 10 quarter time horizon. The year over year sales comparisons I will provide are in constant currency, which thereby removes the foreign exchange impact to sales. Our 2nd quarter results demonstrated both year over year and sequential sales growth and margin expansion led by Commercial Aerospace. The Commercial Aerospace market represented approximately 64% of total second quarter 2024 sales of $320,700,000 2nd quarter commercial aerospace sales increased 21.6% compared to the Q2 of 2023 with double digit growth for both wide bodies and narrow bodies.

Speaker 1

All of the major commercial aerospace platforms grew both year over year and sequentially. The other commercial aerospace category increased 15.4 percent on strong regional and business jet demand. Space and Defense represented approximately 28% of 2nd quarter sales and totaled $138,900,000 increasing 1.4% from the same period in 2023. Military helicopter programs were strong both domestically and overseas including the CH-fifty 3 ks and the Apache. V-twenty two sales were significantly lower as that program winds down.

Speaker 1

While new V-twenty two builds are sunsetting, we will continue to benefit from replacement rotorcraft blades from the existing V-twenty two fleet. F-thirty five was also down in the Q2 of 2024 compared to the prior year period. Our F-thirty five sales have a tendency to fluctuate from 1 quarter to the next as F-thirty five sales were particularly strong in the Q1 of 2024. So on a year to date basis, F-thirty five sales are higher than the comparable 2023 period. Industrial comprised 8% of Q2 2024 sales and totaled $40,800,000 increasing 21.8% compared to the Q2 of 2023.

Speaker 1

Automotive largely aimed at high end performance vehicles witnessed growth, while the remaining industrial submarkets were down. Gross margin of 25.3% the Q2 of 2024 increased year over year and sequentially on improved operating leverage combined with price realization as we work to offset inflationary pressures. As a percentage of sales, selling, general and administrative expenses and R and T expenses were 10.9% in the Q2 compared to 10.8% in the Q2 of 2023. Please note, we will incur a modest amount of expense in 2024 related to the CEO transition, which will hit our general and $61,800,000 or 13.6 percent of sales compared to $61,800,000 or 13.6 percent of sales in the comparable prior year period. The year over year impact of exchange rates in the Q2 to operating income was favorable by approximately 40 basis points.

Speaker 1

Sequentially, the adjusted operating margin improved 290 basis points on higher operating leverage and the absence of the Q1 stock based compensation charge that has historically been incurred at the beginning of the fiscal year. Now turning to our 2 segments. The Constant Materials segment represented 82% of total second quarter sales and generated an operating margin of 17.2%. The operating margin in the comparable prior year period was 16.2%. The Engineered Products segment, which is comprised of our Structures and Engineered core businesses, represented 18 percent of total sales and generated a 14.1 percent operating margin as compared to 8.9% in the comparable prior year period.

Speaker 1

Net cash provided by operating activities was $37,200,000 for the 1st 6 months of 2024, which compares to $30,100,000 in the 1st 6 months of 2023. Working capital was a cash use of $118,300,000 for the 1st 6 months of 2024. For the comparable prior year period, working capital was a cash use of $113,900,000 Capital expenditures on an accrual basis were $41,100,000 for the 1st 6 months of 2024 compared to $70,500,000 in the comparable prior year period. Recall that in 2020 3, we purchased the land and building for our Amesbury, Massachusetts operation for approximately $13,380,000 in the first half of the year. Free cash flow for the 1st 6 months of 2024 was negative $14,400,000 which compares to negative $44,700,000 in the Q2 of 2023.

Speaker 1

Our accounts receivable collections were a little weaker than expected at the end of this most recent quarter principally because the quarter ended on a Sunday. Collections in the 1st week of July were very strong. The Board of Directors declared a $0.15 quarterly dividend this morning. The dividend is payable to stockholders of record as of August 2 with a payment date of August 9. We continue to repurchase Hexcel's stock buying $101,100,000 of common stock during the Q2.

Speaker 1

Year to date through June 30, repurchases totaled $201,800,000 The remaining authorization under the share repurchase program as of June 30, 2024 was $285,300,000 As Tom discussed, we decreased our 2024 sales guidance in relation to continued uncertainty in the aerospace supply chain and we decreased our EPS guidance principally lower on operating leverage combined with cost headwinds arising from this inefficient supply chain environment but also some additional costs associated with CEO transition. This also led us to modestly soften our position around our free cash flow generation. We thrive on predictable demand so that we can optimize our operations including our staffing and asset utilization. Much of our operations are continual flow, operating 24 hours a day, 7 days a week, including holidays. And we are typically sole source, so we must hire ahead of our customer ramps.

Speaker 1

Last year, we had a strong first half of the year, but reductions in narrow body demand ultimately led to a lower second half. Unfortunately, we are now experiencing a similar dynamic in 2024 with some softening or temporary pausing in the pace of forecasted rate ramps in the second half of twenty twenty four for both narrow bodies and wide bodies. Our focus on training, efficiency and factory throughput, however, will continue to ensure HEXO is positioned as strongly as possible for when the ramp increases do take place. As a result, sales and earnings in the second half of twenty 24 are expected to be similar to the first half of twenty twenty four, so a flat second half rather than the growth we were previously forecasting. As Tom said, these near term market disruptions are not significant enough to warrant a change in the midterm guidance that we issued in February this year.

Speaker 1

With that, let me turn the call back to Tom.

Speaker 2

Thanks, Patrick. These past few months of visiting HEXEL sites, meeting our people and learning more about our technology and our markets have reinforced for me everything that I knew about HEXO and significantly more. I'm more convinced today that the opportunities for next generation innovations and lightweighting are compelling and that Hexcel is well positioned to meet this growing demand. With air traffic recovered from the pandemic and backlogs now higher than they were in 2019, the demand outlook over the next several years is very positive. However, based on recent announcements and deliveries from our commercial customers, our view is that the back half of twenty twenty four will be softer than our original expectations and so we have trimmed our guidance accordingly in light of this more cautious outlook.

Speaker 2

Going forward, our goals at Hexcel will be followed: 1st, continue our relentless focus on safety and quality Next, meet our customer production rates increases across all programs. We have a strong capital base and the staffing in place to do so. Invest in productivity to make our factories more efficient as production rates ramp up. Continue investments in research and technology to advance Hexcel's lightweighting solutions and position ourselves to be part of the material systems for the next generation of aircraft, including narrow bodies, engines, UAVs and Space and Defense. Explore additional growth opportunities in adjacent aerospace markets and select industrial submarkets.

Speaker 2

We will selectively look at intergranate growth opportunities, but only when it brings high quality margins and broadens or deepens our innovative material science portfolio to support our efforts to gain more than our fair share of future opportunities. And lastly, continue returning capital to shareholders through dividends and stock buybacks. In conclusion, this has been an incredible 2.5 months. I am more optimistic than ever about the future impact Hexcel's lightweighting materials can have on sustainable aviation future. This one Hexcel team is truly amazing and I am fortunate and excited to have the opportunity to lead this team.

Speaker 2

Rob, we're now ready to take some questions.

Operator

Thank you. We will now begin the question and answer session. Your first question comes from the line of Sheila Kahyaoglu from Jefferies. Your line is open.

Speaker 3

Thank you. Good morning, Tom and Patrick. Tom, congratulations. And just given this is your Q1, I wanted to ask about profitability. You reiterated the midterm guidance, but how do we think about profit given 13% in the second half, as you just said?

Speaker 3

And consensus is embedding about 2 50 basis points expansion in 2025 or about 25% EBIT growth. So how do we think about that margin expansion if volumes don't materialize, especially given that Hexcel is carrying 20% more headcount per plane versus pre pandemic levels? So just kind of how you balance the midterm guidance for profitability?

Speaker 2

Right. Well, Sheila, I think you highlighted the operating leverage that we have. As we continue to recover and revenues go up back toward the 2019 level, that drives an incredible amount of operating leverage to absorb fixed costs and improve margins. Now since we expect that the second half of twenty twenty four is going to be similar to the first half, the margins will be similar as well. But as the production rates continue to increase and revenues increase next year and beyond, that's when we'll start to see the operating leverage kick in and margins really increase.

Speaker 2

So we're not changing our outlook for the midterm that we outlined at the February Investor Day. We simply just trim the guidance for the second half of this year based on some communications, particularly the one from Airbus on G24.

Speaker 3

Okay, great. I'll stick to one. Thank you.

Speaker 2

All right. Thanks, Julien.

Speaker 4

Your next question comes from the

Operator

line of Myles Walton from Wolfe Research. Your line is open.

Speaker 5

Thanks. Good morning. Good morning. Thomas, if I can follow-up on that last comment you made about the Airbus June 24 announcement being the primary contributor. It seemed to be that their contribution commentary is more focused on the 320 and even 330 or 220 than the 350 at the time.

Speaker 5

And I wonder, did the Leonardo pause on the 787 for the composite fuselage, did that have a material contributor to the change in the outlook? Or to your point, was it really Airbus' June 24 communication?

Speaker 2

It was Miles, it was really all of the above. We took a look at a lot of the demand signals that we're seeing in the market, both from Airbus and Boeing as well as some of the other customers. And on the June 24 Airbus announcement, they really weren't specific in the actual release about which programs it impacted. They said it was all programs and that was reiterated in some of their commentary afterwards. And so we do understand that the A350 would be impacted and it's more along the lines of the rate increases that we expected later this year may be pushed out or delayed.

Speaker 2

And that's what we took into account as we made some of our decisions about trimming the guidance. But we also looked at the deliveries that both Airbus and Boeing reported for Q2 and we took into account some of the other announcements like the one that Leonardo made that you just referenced. So it was all of that that we took into account where we felt it was just more prudent to be more conservative and have a more cautious outlook for the second half of this year.

Speaker 6

Okay. And I

Speaker 5

think one of the questions I get is, is the company being more conservative than what you're being told? Or are you just basically mapping to what you're being told? And Tom, this is your first opportunity to sort of reset guidance and expectations. And so I think it's important to understand, are you embedding more conservative assumptions than what you're being told to absorb further deterioration if any?

Speaker 2

I think we're just being realistic based on what we're seeing in reading. And so we're not trying to be conservative or aggressive. It's just being realistic with the outlook. And what I would say is that the guidance change that we made was really more trimming it to align to what we're seeing. And as I said, we've obviously got all the capital in place for higher levels of production and we have the staffing in place to what we were originally forecasting.

Speaker 2

So if the supply chain does stabilize better in the second half and things are better, then we'll look for upside. But we're being realistic in terms of what the outlook is. But we are prepared in terms of our capital and our staffing for whatever the customer requirements are.

Speaker 7

Okay.

Speaker 2

All right. Thank you.

Speaker 6

Thanks, Maas.

Speaker 4

Your next question comes from

Operator

the line of Gautam Khanna from TD Cowen. Your line is open.

Speaker 8

Hey, good morning. Thank you.

Speaker 7

Good morning. Tom, I was wondering if

Speaker 8

you could maybe elaborate. Last quarter, Nick mentioned what rate you guys thought you were on the 787 and likewise on the 737. Would you mind refreshing us on where you are right now? Are you still at 5 a month and low 30s?

Speaker 2

On the MAX, yes, we're still pulling really right now in the low 30s. On the 787, it's been in the 5% or 6% range. We're obviously continuing to monitor the outlook and the demand signals that we get from our customer. And we're staying closely aligned to that. We're literally yes, that continues to be the same case this quarter as it was But yes, that continues to be the same case this quarter as it was last quarter for the MAX and ADS.

Speaker 8

Okay. And just then to be clear, on the guidance revision that you provided today, is this more just anticipation of that which will be conveyed to you at some point? Or is that, as you mentioned, just maybe just reflective of Airbus? I'm just curious.

Speaker 2

It's reflective of everything that we're seeing in the market and also the demand signals that we're getting from both

Speaker 7

of our customers.

Speaker 2

So after the Airbus announcement, they have given us some indication of what the back half of the year will look like and we are staying very aligned to them in terms of what will happen. Now it's important to, I think, also reiterate that our delivery system is quite complex. So for example, on the MAX, we delivered 30 plus locations, on the A320 over 80 locations and on the A350 more than 75 locations. So all of those might have a slightly different demand signal in the second half. We're looking at the totality of it though as we make our determination for our guidance.

Speaker 2

But we feel that again based on what we're seeing and hearing that a more cautious outlook for the second half is prudent and realistic.

Speaker 8

I appreciate that. I guess I'm sorry, just to follow-up one more time. On the Boeing side, are you anticipating being at below the rates you're at in the first half on those two programs in the updated guidance?

Speaker 2

Well, we are going to continue to just monitor what our customers are telling us and stay closely aligned with their production schedules in the second half. I

Speaker 1

mean, Gautam, just to add, I mean, I would I mean, as we communicated, second half sales are going to be very similar to first half sales. So I don't know that we necessarily see reductions, as Tom said. And as Tom said, it's really this is about delays in ramp increases rather than reductions.

Operator

Your next question comes from the line of Bert Subin from Stifel. Your line is open.

Speaker 9

Hi. Good morning and welcome, Tom.

Speaker 2

Thank you, Bert.

Speaker 9

Just to follow-up on Gautam's question there. If we look at the guide you gave, if we look at the midpoint of it for 1.94, it sort of assumes $485,000,000 in sales per quarter for the rest of the year, which would be a step down from the Q2. So is that just looking at sort of mix across the programs and sort of assuming the growth you were starting to get ready for in the Q2 moderates, it sounds like you're not necessarily pulling down program specific production.

Speaker 10

So I was just looking for

Speaker 9

a little more clarity on like the actual dynamics of what happens from 2Q to 3Q.

Speaker 2

Well, what I would say is we expect the second half to look very similar to the first half and that's at about the midpoint if you double it. So as Patrick just said, we're not expecting any decreases necessarily. We're just expecting things to remain flat and for potential increases not to materialize until later.

Speaker 1

But please also remember the seasonality. So we have a seasonality effect. So I wouldn't just assume 3 and 4, Q3, Q4 exactly the same. Q3 is going to have that seasonal effect, especially in Europe. Q4 is going to be strongest and you can kind of put EPS align that as you assume Q4 is going to be stronger than Q3 because of the normal seasonality.

Speaker 1

So

Speaker 7

I know

Speaker 1

I hear your 4.8 5 number, but don't just straight line it.

Speaker 9

Yes, understood. And then just a follow-up on the defense side. Could you give us a little more color? I mean, I think it was helpful, the walk that you did there in terms of talking about the F-thirty five and the V-twenty two. But you had seen 6 consecutive quarters of double digit growth and that's stepped down to 1%.

Speaker 9

Is that expected to sort of step back up? There's just some lumpiness in the 2nd quarter. Obviously, you stuck by your mid single digit guide. But just curious how you're thinking about defense for the rest of this year? And in the midterm outlook, is the view still sort of the same?

Speaker 2

Yes. The midterm outlook is still the same. We're still very bullish on defense. I think Q2 was just a bit lumpy. If you look at the first half of the year, it's still up 5%, 6%, which is very good solid growth.

Speaker 2

And by the way, that's solid growth over 17% last year. So defense is going just fine. There were a couple of programs that had some ups and downs in the quarter. But overall, defense and space are going to be a very strong segment for Hexcel going forward. Thank you.

Operator

Your next question comes from the line of Matt Akers from Wells Fargo. Your line is open.

Speaker 2

Hey guys, good morning. Thanks for the question. Good morning Matt. Tom, I guess I wanted to ask you, you've been around the industry for a long time. So as you go through some of these facility tours, where do you see kind of the biggest opportunity?

Speaker 2

Is there some opportunity to kind of streamline operations there? And how does that translate to kind of cost takeout or worse capital or better throughput or however you kind

Speaker 5

of want to quantify it?

Speaker 2

Right. Well, first of all, Matt, what I would say is that Hexcel has world class facilities. These are premier factories that have the latest state of the art equipment for making these advanced composite materials in all phases of production. It's a continuous process flow. And there's a lot of activity that's underway.

Speaker 2

There's a lot of continuous improvement activity leveraging the best of lean as well as 6 Sigma as well as APQP in terms of quality and efficiency. And there's opportunities for continued digitization and automation. So one of the things that we're doing in fact right now is upgrading the ERP and the MES systems, which are 2 critical systems to factory operations. And that's rolling out now across all the factories over the next 12 to 14 months. So that will be one aspect of improving in the factories.

Speaker 2

The other thing is we've got an initiative which we call our HEXO Manufacturing Initiative or Future Factory, which is really looking at what is the next level of technology to really improve the efficiency of our equipment and improve the output of these lightweight composite materials for the future. And the team has a lot of ideas and we will be basically synthesizing those and putting them into an action plan that we'll be implementing over the next few years. So between continuous improvement, digitization automation and future investments in technology, all of those things represent an opportunity to continue to drive productivity in our factories as we go forward. Very exciting. Great.

Speaker 2

Thanks. And I guess just one more on the industrial, the guidance change there. Could you talk about specifically what end market drove most of that change? Well, as we look at industrial, it's a smaller part of Hexcel's overall business today. Wind has declined a lot.

Speaker 2

The market has just changed. And it really is no longer leveraging the Hexcel Premium Fibers or material systems. So that has diminished a lot. Automotive was actually quite strong and is now the biggest component. And as we go forward on industrial, we'll continue to look for opportunities to focus on premium lightweight materials and where Hexcel can add a lot of value.

Speaker 2

And we do see some opportunities in some of the submarkets, but it's clearly changed and that's why we guided to double digit decline this

Speaker 1

year. I would just sort of say exactly as Tom said. So wind continues to decline perhaps even slightly more than we expected. But really it's automotive We had a soft Q1 in automotive. If you remember, the growth in automotive just won't be quite as strong as we initially expected when we gave the guidance in January.

Speaker 1

That's really the driver.

Speaker 2

Got it. Thank you.

Operator

Your next question comes from the line of John McNulty from BMO Capital Markets. Your line is open.

Speaker 11

Yes. Good morning. Thanks So I guess the first one is around the cash flow and uses. So your buyback was more aggressive than we've seen in a while in the first half of the year. It's almost on pace to kind of match your full year free cash flow.

Speaker 11

So I guess how should we be thinking about your comfort in continuing to kind of push on that buyback program just given where the stock is right now as we look through the rest of the year?

Speaker 2

Well, I think you're exactly right is the buyback in the first half of the year is basically our outlook for free cash flow for the full year. So we're very bullish on the future for Hexcel stock and we saw a great opportunity in the Q1 and the Q2 to buy. And so we'll continue to monitor the situation. We will look for opportunities to continue the share repurchases. And I think what you said is completely accurate.

Speaker 2

It was a great opportunity to buy and we took it the first

Speaker 11

half. Got it. Fair enough. And then maybe just a little bit more on the commercial aerospace kind of slowdown in terms of your numbers or at least leveling off maybe with the first half. Is this when you think about the second half and how things progress and also the timing of when you're delivering for, where you're 6 months in advance of when your customers need the product, is there a risk just given the supply chain issues that this slowdown or this more muted rate drags on into the first of 2025?

Speaker 11

I know it's a little bit of a pull out of crystal ball, but I guess what you're hearing from your customers, I guess how are you thinking about if this could drag into the first half?

Speaker 2

We're not anticipating that. The messages that we're hearing was the second half of twenty twenty four is going to be a little softer than expected. And so what I said is we're not seeing rates going down, but rather some of the increases being delayed and pushed out. Next year and beyond looks just as strong, if not stronger than before. And by the way, if the back half of twenty twenty four, if the supply chain stabilizes there's upside, we'll be prepared to deliver on it.

Speaker 2

So we trimmed our guidance because of what we're hearing, but that's only really related to the second half of twenty

Operator

twenty four.

Speaker 2

2025, twenty twenty six and beyond still look very strong given the strong recovery in air traffic and the backlog and the increase in production rates that we see coming.

Speaker 11

Got it. Thanks very much for the color.

Operator

Your next question comes from the line of Gavin Parsons from UBS. Your line is open.

Speaker 12

Hey, thanks. Good morning.

Speaker 2

Good morning.

Speaker 12

Tom, it sounds like you have some guidance from the OEMs, but maybe you're still having to guess as to what production rates might be? And I know you talked about the complexity of the ship to locations, but is there any way you can improve visibility or line of sight on that front?

Speaker 2

Well, it's been a challenge for the whole industry over the last couple of years. Despite the fact that there is strong air traffic recovery, there's huge demand for aircraft that's reflected in the orders in the backlog. It's just been a little bit harder to predict production and deliveries because of a lot of supply chain disruption. And so I wish we all had a crystal ball to see a little bit better, but that's just the reality of the situation. And so we try to be pragmatic and realistic about what the second half of twenty twenty four looks like in terms of trimming our guidance.

Speaker 2

But the medium and longer term outlook hasn't changed. Air traffic has recovered to well above 2019 levels. The backlog is bigger than it was pre pandemic and production rates are going up across all the programs over the next few years. So Hexcel has the capital in place to meet that demand. We have the staffing in place for short term requirements.

Speaker 2

And the outlook is very good. It's just the back half of twenty twenty four is a bit softer than we originally expected and we trimmed the guidance quarterly. Got it. That makes sense.

Speaker 12

Any way that you can quantify how labor efficiency or utilization has improved over the last few quarters after the hiring in the second half of twenty twenty three?

Speaker 2

Well, you see it reflected in the improvement in the margin and that's really a reflection of the operating leverage that we get. So don't forget back in 2019, HEXO's revenue was about $2,350,000,000 and we had the same capital in place and the headcount was a little bit higher, but the margins were in the 18% level. So as the revenues recover, you'll see the operating leverage drive margin improvement and some of that will be due to labor productivity efficiency as well.

Speaker 6

Thank you.

Operator

Your next question comes from the line of Scott Micas from Melius Research. Your line is open. Good morning.

Speaker 13

Patrick, are you baking any conservatism into the guide for a potential strike at Boeing and How that could impact their demand pool?

Speaker 1

Yes. I mean, the simple answer is no. I think that would be a step too far. We're obviously very conscious of that negotiation about to happen. We will stay very close and as we always do align ourselves with our key customers Boeing and others in this case.

Speaker 1

But no, we have not built in a strike, but we will obviously stay very vigilant and we will respond, react accordingly. I think that would be a little bit too much to put that into our guidance.

Speaker 13

Okay. And then for Tom, when you were at Spirit, you worked to diversify the sales mix to get more aftermarket and defense work. At Hexcel, do you think there needs to be some aftermarket exposure that you can get through inorganic means? And then if so, has the Board given you the mandate to pursue that goal through M and A?

Speaker 2

Well, the discussions I've had with the Board are very much focused on continuing to drive growth at Hexcel. And we're going to do that in a variety of ways. You mentioned defense and space. That's a key opportunity for Hexcel. We've got a very good platform and base and last year grew 17%.

Speaker 2

We're going to expect new growth as we go forward. So that's one big opportunity. We'll continue to look for other adjacencies. Aftermarket is probably a little tougher for Hexcel given the lightweight materials that we provide. There aren't as much there's not as much obvious opportunity in that.

Speaker 2

We'll look for it, but the opportunity for us is to continue expanding our lightweight materials and next generation programs and expanding into some adjacencies, including defense and space and some industrial submarkets. That's where our focus is and that's clearly what the Board wants to see is more growth as we go forward with continued profitability and margin improvement as we get the operating leverage with revenue recovery and continue to drive efficiency in our factories.

Speaker 13

Thanks for taking the

Speaker 2

questions. Thank you.

Operator

Your next question comes from the line of Ken Herbert from RBC Capital Markets. Your line is open.

Speaker 10

Hi, good morning, Tom. This is actually Steve Strakaus on for Ken Herbert. I was wondering if you could give us a little bit more broader detail of what you're seeing at Hexcel from an OE build rate perspective now as compared to when you kind of first joined? And then if you can kind of further bridge that between what you were seeing at Spirit when you had left there as well. I think that might be really helpful from an industry perspective.

Speaker 2

You mean in terms of what we're getting on build rates from the

Speaker 10

Either build rates or just the supply chain generally as well. I think all of that kind of commentary would be helpful as we kind of dissect the build rates here.

Speaker 2

All I would say is that the communication and the relationship and the partnerships with all of our customers, including the major commercial OEMs Boeing and Airbus, is very strong at Hexcel. We have a very active dialogue. We stay connected to them in terms of what their build rates are and what their future outlooks and plans are. And so I would say the dialogue and the information and the transparency is the same as I've seen elsewhere on that. And that's very important and we're going to continue to do that because this is a very dynamic environment.

Speaker 2

It's extremely volatile. There's still some instability in the supply chain. And we want to stay very close to our customers and make sure that we are aligned to what their current outlook is and continue to evolve with that.

Speaker 1

I mean the one thing I would just add is Frank just to state the obvious is that Hexcel's supplying materials is different to many other suppliers sort of including spirits. So we tend to be earlier in the supply chain where, as we've said many times, sort of 4 to 6 months ahead, sometimes more, sometimes less, but largely. So you have to sort of think about that offset for Hexcel. So that is a difference. There's the reality of where Hexcel is in the supply chain.

Speaker 10

Okay. And then maybe just one follow-up as well. I realize you guys have done about $200,000,000 in share repurchases with about $285,000,000 left in the authorization. Do you anticipate any change in the capital allocation priorities, maybe looking to expand that $285,000,000

Speaker 2

Well, the $285,000,000 gives us plenty of headroom to do a lot more share repurchases. And our goal is to keep our leverage in the 1.5% to 2% range and to look at what our free cash flow generation is and determine how we want to allocate the capital. Right now share repurchases are a very good use of cash and we obviously did a lot of it in Q1 and Q2 and we'll continue to look at the opportunity in Q3 and Q4 as we go forward.

Speaker 10

Awesome. Thank you so much.

Speaker 4

Your next question comes

Operator

from the line of Pete Skibitski from Alembic Global. Your line is open.

Speaker 4

Hey, good morning, everyone. Hey, Tom, just in the way of thinking about other kind of land mines that are out there or risk factors and maybe this first one, I think I know the answer. But the storms that rolled through Houston, it's a big commodity town, big oil and gas town. Are you guys anticipating any material availability issues as a result of the storm that rolled through there?

Speaker 2

Not right now. No. I mean, we obviously monitor the situation. We're in close touch with our suppliers on our resins and in our acrylonitrile, those kinds of commodities. And we're not hearing anything right now that gives us any concern from those storms at all.

Speaker 4

Okay. Okay. And then kind of with your unique vantage points, as Spirit, we all anticipate Spirit to be absorbed by Boeing and partially by Airbus. Can you foresee any kind of issues with production rates as a result of that dynamic?

Speaker 2

No, we don't. We expect that to be a smooth transition and the contracts will just carry on as they were before. So we don't anticipate any issues whatsoever.

Speaker 4

Okay. Thanks for the color.

Operator

Your next question comes from the line of Michael Ciarmoli from Truist Securities. Your line is

Speaker 6

open. Hey, good morning guys. Thanks for taking the questions. Tom, maybe just back to the 26 targets that you inherited. I mean, we've seen a lot of struggles in the supply chain.

Speaker 6

Looks like 26 or to get there, it looks like going to be more back end loaded. I mean should we just be thinking more on the low end of this? I mean it would seem like it would be a challenge to get to the upper end now especially with the neo kind of rates getting pushed out. And I mean, we don't really have that much time here for these wide body rates to double. And I mean, I think the confidence level in the supply chain, we probably got to be more conservative.

Speaker 6

So should we think about more of the low end? And then I guess at the same side, is cash flow generation still thinking greater than 800,000,000

Speaker 2

dollars Yes. Well, look, I wouldn't change the midterm outlook at all. We're very confident in the outlook. I wouldn't be saying low end, I would be saying the same, if not even better. The demand is there and the plans are in place to increase the build rate.

Speaker 2

So we said $800,000,000 over the 3 years and we're going to keep to that and look to exceed it. We're very bullish on the midterm outlook and we feel confident in it. Some softness obviously in the back half of twenty twenty four, but the outlook for 2025, 2026 and 2027 still remains very strong, if not stronger based on the recent orders and the recent indications on production rates. It will be interesting to see what happens in Farbrough and what kind of orders come out particularly for wide bodies. And that's probably, if anything, just going to improve the outlook.

Speaker 6

Got it. Got it. Just the last one on the cash. Given your product has a shelf life, given this kind of softness in the back half, any kind of destocking risk or any kind of thing moving around with inventories that we

Speaker 11

should be aware of?

Speaker 2

No, I don't think so. In terms of the shelf life for the product, it's a fairly long time. It's kept in freezers. It can last for over a year. And there's plenty of freezer capacity out there because everybody was producing at much higher rate before the pandemic.

Speaker 2

So that's not an issue whatsoever.

Speaker 6

Okay. Got it. Thanks, guys. Thank you.

Operator

Your next question comes from the line of Richard Safran from Seaport Research Partners. Your line is open.

Speaker 7

Tom, Patrick, Kirk, good morning. So for cash conversion, way back when you did see a path to 100%, made it clear you weren't sure that was going to happen in 2024. But I'm wondering since you're maintaining your bullish midterm outlook, is that something we could see in 2025? Or might 100% cash conversion be more like 26? Percent?

Speaker 7

No.

Speaker 1

I mean, I think the softness we're seeing, and it's not massive softness. I mean, it's a 2% adjustment in top line revenues sort of putting in perspective. We still see that line to 100% net income cash conversion, 25% beyond. We're clearly moving in that direction and we still have that confidence, Rich.

Speaker 7

Okay. And then just lastly here, one more question on M and A. I know you're asked this every once in a while. You've been pretty consistent about what you're considering in technology bolt ons. I thought maybe though you could comment a bit on the environment and the opportunity set.

Speaker 7

If you're seeing attractive deals or since it's been such a while, is this a case where prices may just be too high and you can't justify the investment? And on that topic also, do you think the portfolio as it stands supports your growth strategy?

Speaker 2

Well, I'll take that one first. In terms of the portfolio, absolutely, it supports the growth strategy that we have. We've got the recovery first over the next several years as production rates increase and we get back to 2019 levels of production revenue. And then we have some new opportunities in space and defense, which will continue to help us grow. On the M and A front, we're going to continue to scan the market and look for opportunities, but we're going to be very disciplined.

Speaker 2

We've got a lot of work to do in terms of execution on the rate increases and continue to drive productivity in our factories and continue to innovate so that we can be on the next generation of programs including the narrow body as well as fence and space. So that creates a huge amount of organic growth over the next several years. And for M and A, we'll look for things that extend our advanced composite materials and provide some technology innovations. But it has to meet our strategic criteria and also we'll have some very high return threshold that we'll have to meet. And absent that, as we said, we'll continue to issue our dividend and consider future stock repurchases.

Speaker 7

Thanks a lot.

Speaker 2

Thank you.

Operator

And our last question today comes from the line of Noah Poponak from Goldman Sachs.

Speaker 7

Your line is open.

Speaker 14

Hey, good morning, everyone.

Speaker 12

Good morning, Noah.

Speaker 14

Given that the large commercial aerospace OEMs appear to be pulling from the supply chain at higher rates than their deliveries to keep the supply chain humming along for when they eventually are ramping more consistently. How should we be thinking about the risk of how much inventory is in the system, especially given your longer lead time? And I guess how much of the back half change is expecting an inventory destock? And do we have to think about that happening beyond 2024?

Speaker 2

Well, I think that is part of what's happening right now. As the OEMs are ensuring that the supply chain can continue to get stable and to improve their efficiency. So as production rates go up, they're ready to do it. So I think it's just a question of smoothing the production over a time period and not trying to front load it too much. So I think what the OEMs are doing is prudent and it's going to help improve the stability and the financial and the operational strength of the supply chain.

Speaker 2

So I think it's a good and a prudent approach to the production rate increases. And it's all about smoothing the demand between this year and next year so that the supply chain can get back to stability.

Speaker 1

MAX. I mean, I'm not saying it's not happening on the others a little bit, but the only meaningful one is the MAX. And I would remind you of the shift set for XL on the MAX sort of at the lower end of the 200000 to 500000 range. So really a destocking impact because of an adjustment is not massive for Hexcel on that particular program where that sort of pull is slightly ahead of production. But as Tom said, we're very vigilant on this, but it's not we're not expecting a huge impact.

Speaker 14

Okay. That makes sense. And then, Tom, respecting that you're here now and you're not at Spirit now, but just given your ties to the company and then I guess you sell to Spirit now. Boeing seemed to have the cleaned up and the traveled work in particular was no longer taking place and the fuselages were clean into spec. I guess the June underlying production rate on the MAX looked pretty healthy, But I don't know, do you have any insight into where that stands?

Speaker 2

I really don't. My whole focus has been on Hexcel and I'm excited to be here and looking forward to the future. We've got a great opportunity as we go forward. So I'm excited about it.

Speaker 14

Okay. Thank you.

Speaker 2

Thank you.

Operator

This does conclude today's conference call. Thank you for your participation. Everyone, you may now disconnect.

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Earnings Conference Call
Hexcel Q2 2024
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