Q2 2020 Hexcel Corp Earnings Call
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[music] good morning, everyone. Welcome to walk so corporations second quarter 20 to 20 earnings conference call before beginning let me cover the let's see first I want to remind everyone about the safe harbor provisions related to any forward looking statements we make during the course.
This coal.
Certain statements contained in this call may constitute forward looking statements within the meaning of supply that Securities Litigation Reform Act of 1995.
Involved estimates assumptions judgment and uncertainties caused by a variety of factors could cause future actual results or outcomes to differ materially from all forward looking statements today.
A detailed in the company's FCC filings last line news release.
A replay of this pool will be available on the Investor Relations page of our website.
Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material it cannot be recorded or rebroadcast without our expressed permission.
Your participation on this call constitutes your consent to that request with me today on Nick Stanage, Chairman, CEO, and President and co caught all Vice President Investor Relations.
Because of the goal is to review second quarter Twentytwenty results detailed in our news release issued yesterday.
Now, let me turn the call I've accident.
Thanks, Patrick Good morning, everyone and thank you for joining us as we share or second quarter results.
Looking back at the scenario planning, we do part of our annual strategic reviews, no. We could've been managing the specific nature and magnitude well the global pandemic, an economic consequences, we are experiencing today.
Understanding learning and adjusting in real time should today's realities are essential steps to delivering shareholder value.
Our one hexcel team will continue to act quickly and aggressively.
We will remain vigilant in response to our customers.
Position the company to be even stronger when growth returns.
As you saw in our release last night, the Qubits 19 pandemic had a significant impact on her second quarter sales operating income and earnings per share.
These results are disappointing yeah not surprising.
What's that kind of dynamics upside on air travel in the global economy unfolded earlier. This year, we think swiftly to assess the steep decline.
And knew that the impact on aerospace and industrial industries would lead to one of our most challenging yourself.
Commercial aerospace has been impacted significantly as a result of the pandemic and we expect this downturn will extend for some time to calm.
As you know year over year global flights are down more than 50% and major airlines are flying well below their plant capacity levels.
In our commercial aerospace market.
<unk> is down for both white body and narrow body aircraft as well as business Jets.
Our industry currently faces declines in deliveries orders and backlogs, while rising cancellations and deferrals indicate it could take a number of years before we see full recovery.
In addition, werent jeans shelter in place orders, social distancing and personal income loss are contributing factors that have negatively impacted our industrial segment, especially automotive and recreation as consumers delay or cancel plans for major purchases.
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[noise] all in all we have rarely faced a headwind of this magnitude that materialized, so quickly and impacted us so significantly.
For us to rebound and recover we readily accept the challenge to stay Andrew responded rapidly to market signals and continue to push the boundaries for even greater operational excellence and.
And we are doing just that.
In early April we announced plans to take a combination of decisive actions.
Minor operations with courage and forecasted demand.
We continue to target labor cost reductions of about 30%, which today includes approximately 1600 job eliminations as well as temporary reductions in salaries and furloughs.
Hiring and promotions around home and we have cut overhead costs by reducing or eliminating discretionary spending.
Minimizing capital expenditures.
We do see benefits and more.
We have more work to do particularly in some countries we're processes for restructuring take time.
As we restructure our organization, we continue to simplify and streamline processes will enable and leverage our strong and talented team.
I can assure you that as painful as it is for us to lose team members, we will right size our company to ensure that we continued to deliver strong shareholder value.
Sales in her second quarter were $379 million down 38% year over year.
Adjusted diluted EPS was eight cents compared to 94 cents in the second quarter of 2019.
We delivered second quarter operating.
Adjusted operating income of $19.5 million with a margin of 5.1% compared to 18.9% in Q2 2019.
Now, let me turn to our three primary markets.
Commercial aerospace build rates have declined rapidly in response to the cold bid 19 pandemic and sales were current correspondingly lower across all programs with the Airbus Athree hundred 50, representing the largest revenue drop.
In addition, significant inventory reductions in the supply chain contributed to the decrease in sales.
In other commercial aerospace, we saw 25% year over year decline in revenue.
As mentioned in our news release last night, one of the most impacted areas as a result on the supply chain correction has been on the demand for our carbon fiber.
As a result, we have temporarily idled a large part of our capacity to match build rates and reductions in demand.
We're communicating regularly with our customers and remained a line and flexible to meet their expected production supply chain requirements.
For space and defense lower demand in a number of international programs contributed to a modest sales drop.
If we look only at U.S. space and defense sales were up slightly.
Our position in space and defense had been growing, especially with our acquisition of our technologies.
Current indications are that's key defense spending will continue at current levels and we remain optimistic for this sector.
Wind energy sales are the largest submarket in industrial and sales declined 13.6% year over year.
The decline can be attributed primarily due to production disruptions in Q1 that extended into the second quarter and general endemic headwinds.
In the second half, we expect continued challenges not only resulting from this and Dominic.
But also from increased cost pressures in the wind energy industry in general and specifically for wind turbine blades.
As we look forward, we remain optimistic and are viewing this pandemic as a unique opportunity to reevaluate everything we do to ensure that we are focused on the things that mattered, most and will support our recovery.
Those include maintaining or strong customer relationships.
Investing in innovation.
Driving operational excellence.
And creating long term value for shareholders.
Well it feels like everything has changed over the past few months nothing has changed about who we are so.
Where a world leader in advanced composite technology.
Even in the face of lower demand and softer sales, we remain a key technology supplier to our customers with whom we share strong and collaborative relationships, that's will serve us well for years to come.
Our near term objectives are clear.
Staying agile and such along with a sharp focus on taken decisive actions today.
Apparels for a strong recovery and sustainable future growth.
On the innovation from our RMG teams continue to focus on new products and new formulations, especially for next generation aircraft.
This works helps to solve our customers' most pressing challenges.
Unsecured both existing and new business that will position us for even greater growth in the future.
Not only is this the time to further secure XL as a global leader in advanced composite technology. It also has an opportunity to closely examine our entire supply chain to drive efficiency and optimize inventory levels to generate cash.
All of these actions will strengthen our foundation and better prepare us to take advantage of the recovery and strong growth that we believe lies ahead.
We further strengthened our balance sheet during the second quarter of 2020, increasing liquidity by $53 million, while realigning our cost structure and global head count.
We were taken decisive actions to reduce costs generate cash and staying close to our customers to understand the market demand dynamics.
Now I'll turn it over to Patrick to provide more details on the numbers.
Thank you Nick.
As a reminder, the year over year comparisons are in constant currency. The majority of our sales is denominated in dollars. However, I'll call space is a mix of dollars euros and British pounds as we have a significant manufacturing presence in Europe.
As a result, when the dollar strengthened against the euro in the pounds on sales trends, they Noah, but across all sites and state lover, leaving to a net benefits while margin accordingly, a strong dollar is favorable swap financial results.
We had to these currency exposure over a 10 quotes a horizons pretax operating income.
Quarterly sales totaled $378.7 million the significant year over year sales decrease was due to rapid production rate decreases by our customers in response to the pandemic, which was magnified by de stocking across all product lines.
Turning to our three markets.
Mustard aerospace represented approximately 54%.
Total second quarter sales.
This is a significant shift is historically commercial aerospace is represents close to 70% of on total revenue.
Commercial aerospace sales were $203.9 million decreased 51.5 per cent compared to the second quarter 2019.
We were expecting a steep decline following substantial production costs by our customers combines with de stocking of channel inventory.
All size sales to the powering 737 mass platform with substantially lower year over year.
No rate 737 mass production resumption injecting the second quarter only led to minimal sales as a result at the high volume of inventory in the supply chain.
We expect channel de stocking across the major aerospace programs continue beyond the second quarter of 20 to 20.
This is impacting our entire product range, including pretty plagues and direct carbon fiber styles.
Carbon pretty price represent the most significant portion of our comps its business and as a reminder.
Those pretty price a carbon fiber impregnated with one of our proprietary resin formulations.
We also sell carbon fiber directly to others, who then price that's it into parts de stocking of carbon fiber has been significant suggesting a high level of inventory in the channel.
Although painful in the near term. This one time supply chain realignment will ultimately establish a new right sized inventory base across commercial aerospace that will support sustainable growth in the future.
[laughter] space and defense represented 29% sales and for the second quarter totaled $190.4 million decreased 3.6% compared to the same period in 2019.
The decrease was due to lower international demand for space and defense as the U.S. space and defense sales increase nominally year over year.
We are experiencing net disruptions with customers and supply chain from the pandemic. So overall, we remain bullish on on space and defense business 10, but of course by the continuing impact of the pandemic.
Industrial comprised 17% to second quarter sales industrial sales totaled $66.4 million decreasing 16.6% weakness across the many different submarkets within our industrial space, including wind energy also might.
Okay, and recreation, primarily due to the pandemic.
For our wind energy business, we supply the golf fiber composite material that is used by the wind turbine manufacturers to make that blades in house.
We are beginning to witness greater outsourcing of to manufacture of complete when blades as cost pressures increase in the wind industry and we expect these outsourcing to continue.
Wind energy remains the largest submarket within industrial comprising more than 60% of industrial sales.
On a consolidated basis gross margin for the second quarter was 14.5% compared to 27.7% in the second quarter 2019.
We are facing substantial headwinds from underutilized capacity and mix. Additionally cost realignment actions continue during the quarter and further restructuring efforts are ongoing it's on manufacturing process with the benefit is taking a number of months to be fully realized.
Selling general and administrative expenses decreased 38.7% in constant currency as we reduced headcount and tightly controlled discretionary spending.
Nice to head count reductions in this area, we initiated throughout the quarter.
Continuing.
Research and technology expenses decreased 19.2% in constant currency as we reduced costs across the business.
Keep in mind, the heck salaries in advanced materials Science company focused on innovation, Argentina drives this innovation. So our cost realignment actions are the most selective in research and technology.
The other expense category consists principally of severance costs predominantly in the U.S., we will be incurring additional severance costs in the upcoming periods for further labor reduction actions being developed some of which have already been initiated.
Adjusted operating income totaled $19.5 million or 5.1%.
This decline in March and reflects the rapid decreasing sales business mix impacts related to lower styles of carbon fiber and the lag effects of cost reduction actions.
Total depreciation expense increased $9.9 million as we tightly managed all capital expenditures.
The year over year impact of exchange rates was unfavorable by approximately 40 basis points.
Before I discuss south segment results I would like to make a few additional comments on operating margins.
While we have withdrawn financial guidance due to the pandemic uncertainties based on early conversations with our customers on our visibility of inventory in the supply chain at the time, we previously communicated our police that we'd be able to deliver double digit operating margins on an annualized basis throughout the cycle.
Hello.
Now that we have better visibility of the supply chain and more clarity from our customers, we recognize achieving that level of margin new twentytwenty is going to be challenging.
We remain determined to drive up cost actions strongly and worked aggressively to maximize our performance.
For example, during the quarter it became clear to US there was more carbon fiber uncompleted Pos in the channel than we previously had visibility to.
Which is leading to a greater level of de stocking than previously anticipated.
The near term reduction in fiber sales, particularly has a significant mix impacts on our overall margins. Additionally, the production recovery for the 737 Max is expected to be lower than we previously understood.
Now turning to our two segments. The composite materials segment represented 81% that total sales, which is consistent with historical toxins.
Operating income margin was 6.3% for the second call sort of 20 to 20 as compared to 22.1% much in the prior year period.
The engineered products segment, which is comprised of our structures and engineered core businesses represented 19% to total sales and generated a negative 1% operating margin compared to 13% in the second quarter of 29 team.
Engineered products was hit, particularly hard by the Mac situation as well as the general pandemic impact.
As a reminder, engineered products requires a much lower level of investment in comps and materials.
Under normal market conditions generates attractive returns on invested capital.
The adjusted effective tax rate for the six month period ended June 30, 2020 was 21.9%.
The expected effective tax rate for the remainder yeah continues to be 23%.
Net cash provided by operating activities with $65 million for the second quarter 20 to $27 million to $3.6 million year to date.
Working capital as a source of cash of $43 million in the quarter.
We expect to continue it continued to generate cash from working capital during the second topic Twentytwenty.
Capital expenditures on an accrual basis grew $11.5 million in the second quarter Twins 20, compared to $50.1 million for the comparable period in 2019, we continue to curtail capital expenditures.
Free cash flow for the second quarter, Twentytwenty was $51.8 million compared to $73.1 million for the comparable prior year period.
We remain focused on generating and preserving cash we expect to higher level of free cash flow generation in the second half of the yet as we manage inventory levels and maintain our strong receivable collections.
Our share repurchase program remains temporarily suspended so we did not buyback any shares during the second quarter.
Board will continue to evaluate share repurchases as well as the resumption of course meet dividend payments.
We further strengthened our balance sheet as we increased our liquidity by $53 million as of June 2020, compared to March 31st one's 20.
Total liquidity at the end of the second quarter 220 was $689 million.
Consisting of $257 million of cash and $432 million.
Undrawn revolver availability.
XL has an investment grade credit rating, which reinforces the belief and off balance sheet strength.
We have no near term date debt maturities.
Our 1 billion revolver materials in 20 to 24 and onto senior debt notes mature in 2025 2027, respectively.
When markets are predictable, we operate with a minimal cash balance as our business generates cash late in first quarter 2020, we proactively with through $250 million from the revolver due to the pandemic uncertainties based on the confidence we now have with continued.
Cash generation and the financial strength of our bank Syndicate, we repaid $125 million of the revolver balance in June.
Our leverage is measured on a gross debt basis and was 2.8 times at June 20 to 20 compared to 2.5 times at March 31st 20 to 20.
We remain well within covenants conditions.
In closing, we continue to drive cost alignment protect the balance sheet.
Ash generation.
With that let me turn the call back to Nick.
Thanks, Patrick.
Before we open the lines for questions I want to take a moment to recognize our sole team.
The past few months have been extraordinary yes, our dedicated workforce has stayed focused and see while meeting our customer commitments.
Redefine our processes to include extra precautions, maintaining social distancing.
Using enhanced personal protective equipment.
Many of taken pay cuts were for lows.
It has been difficult to say the least with achieve remains strongly committed and determined to deliver a great future for himself.
Throughout it all our team stepped up in remarkable ways.
For example, our plants have produced and donated hand sanitizer throughout the us in Europe.
We shipped part of our own inventory of respirator masks.
Flyers in need and we don't needed masks and other supplies to local hospitals in Europe and the U.S.
Employees made intubation boxes for hospitals and some of the hardest hit areas in the U.S.
Well all be Im certainly achieved fear.
Route safety performance is tracking better than last year.
I wouldn't be prouder of the resilience that our team shows every day, even during these challenging times.
The actual leadership team and I continue to strengthen exclusion and expand our diversity initiatives throughout the organization.
One of our core values, something we call one heck so.
And it means that we have a common purpose and that we support one another in achieving that purpose, regardless of who we are where we work in our role within so.
Yeah. So on the contributions each individual brings to our company as we strive to and body and inclusive and diverse culture consistent with one has solved.
In summary.
Let me assure you that heck so.
Opposition is unchanged.
We understand that the aerospace and industrial industries will take time to recover and they will recover equestrianism Nia rather how soon.
People will fly again, both domestically first and then internationally and airlines will once again order new high performance composite rich aircraft to meet growing demand.
The trend toward integrating our strong lightweight materials next generation aircraft and industrial products remained strong.
Our focus is on procuring now so we are ready.
We recognize that the road ahead of us as a long uphill climb.
I can assure you that helps all those up the challenge.
Commitment to operational excellence is unwavering and its impact on cost savings and productivity has never been more critical.
Drive towards continuous improvement processes and perfect quality becomes even greater as we operate with fewer resources.
I've said it before I'll say it again.
Crisis passes no company will be better position to supports customers and XL.
With leading technology leveraged by our passion innovation strong customer relationships that will grow even stronger during these challenging times.
A talented resilient team that procedures in the face of any challenge.
I'm confident that our business will strike in future.
Juliane, we'll now turn it over.
Take questions.
Thank you as a reminder to ask your question. Please press star followed by the number one we ask that analysts. Please limit themselves to one question. Thank you. Your first question comes from Calton contact from Cowen Your line is open.
Thanks, Good morning, guys.
Morning.
Maybe.
Gentlemen for both of you I guess just on the.
Channel inventory.
You mentioned that might take a number I think you said quarters global.
But I wanted to make sure you know how how much of the destock you think you felt in Q2 and any sense for how much.
Longer we should expect it and you know on which programs. If you can identify them the inventory overhang is greatest.
So I'll take a shot to start with.
And again, if you look at the Destocking, it's pretty much directionally related to the percentage of the build rate reductions across the platforms.
The impact to Hacksell is clearly going to be greatest for those programs where.
We had.
Hi, build rates that have come down significantly on high Shipset content and you guys see them out.
Threefifty being clearly one of the biggest.
You know 737, Max obviously has had some inventory correction that's been happening throughout the year even in Q1.
Based on what was going on.
In Q2.
Really started seeing the magnitude of the commercial aerospace reductions across the board and it's our belief that's going to continue very strong into Q3.
We're hopeful that it will subside, but again, it's going to be very dependent on where we always.
Ultimately land on 2021 production rates, which as you know are still being discussed and evaluated based on revenue passenger travel.
So we're keeping a close eye on it.
We have good visibility, we're getting better visibility, we're working very closely with our customers.
To understand what's in their supply chain into out.
So galva, Matt that's kind of wherever we are we certainly see an extension into Q3.
Yes, maybe just any specific comments on the eight seven program, where it's a more gradual decline and production rate than what we're seeing on the 350 and some of the other platforms.
Being customers starting to get ahead of that.
And destock more dramatically than the.
Gradual decline were seeing them up program.
Thank you know I I would say nothing nothing really jumped out abnormal it's kind of along the lines of the production rate.
So we haven't seen any major surge of each sub and inventory come out in most logs and we expect that to gradually work through the pipeline.
Thank you very much guys.
Thank you got them.
Your next question comes from Robert Spingarn from Credit Suisse. Your line is open.
Yes, hi, good morning, just following up on a GAAP and was just saying, though we've heard some other supplier say on the eight seven.
That their calibrating the 10, but of course are gonna have to calibrate to seven.
Probably a year from now and so when you factor in the de stocking in the continued decline it sounds like that's one program that could be a lingering source of pressure is that fair.
Yeah, I think that is fair.
From 14 to shop and.
Not only to build rate to fund dependent but when you're at a rate of 14 buffer stocks are much bigger than they are required when you're running at a rate of seven so it's right sizing to that build rate right sizing buffer stock and until we get to a run rate at the sub the number if that's still the final number.
[music].
There will be continued squeezing of that supply chain Robert.
Yeah, and and Nick on that to what extent have the major customers some thinking Airbus and Boeing to what extent are they looking at what your minimum production thresholds are to maintain a safe.
A secure supply chain they talk about at all the time, but is that a real conversation that's actually happening what are the minimums that you can produce that because some extent we look at the balance between returning aircraft from the desert versus new aircraft.
Some extent, it's what do you want to plug into the capacity how many new aircraft do we need versus old aircraft and then factoring the health of the supply chain.
Yeah, I I couple of comments I mean, historically, we've seen that the longer planes are idled and sitting out less likely they already get pulled back into production, having said that shifting we are talking basically daily with Boeing Airbus and virtually all of our customers.
To stay aligned with them I would have to tell you with Boeing and Airbus specifically, we have not had the question on what is our minimum.
Production levels will be sustainable simply because of strength of our balance sheet flexibility. We have the responsiveness, we've taken in taking cost out.
And just how critical we are both their operations. So we're very aligned I think they have confidence in us I think they've seen that we worked hand in hand with them to help them get through their troubled times.
And that's what we're continuing to do today.
Okay. Thank you.
Thank you Robert.
Your next question comes from Richard Safran from Seaport Global Your line is open.
Thanks, Good morning, Nick Patrick and Curt how are you.
Good morning retiring.
So.
I wanted to just first ask your question about R&D thinking a bit strategically so R&D was down.
Clearly part of your cost controls you state that at the same time, though you're looking to move into some new defense markets I thought you might comment on what the right balance of R&D should look like when current markets are in decline, but you're also looking to expand into new markets.
Yeah, Great question and great timing cents last week, we had our global team for three days of strategic plan reviews, we do that every year and it's the precursor to get ready for our board strategic plan reviews in September.
The only difference this year they were done virtually and I have to say with the technology.
We really had productive discussions having said that.
Yeah, we focus and we live on technology and partnering with our customers to work on new opportunities space and defense have quite a few new opportunities and.
Unmanned slight electric vehicles drones alter what we would look at as maybe a little more niche applications with many more suppliers well theres a lot of activity in that area and we're prioritizing that we're working and.
Allocating our resources accordingly in that space.
Hi.
I don't want to send the message that we focused on space and defense, we have opportunities and commercial aerospace on some new initiatives with new technology.
And lower risk areas, where we can displace older technology and those are being emphasized and refocused and prioritized and then in the industrial segment, where you can have the ability to drive demand a little quicker lifecycles aren't quite as long that's another area, where we're targeting.
Some specific investment and allocation of resources. So she is a huge element. We spent a lot of time continuing to look at the technology that we're focused on.
Look at the technology that we're deferring or where we're putting on the back burner for the time being.
Make sure we're really supporting our customers on what they need near term and mid term.
Thanks, just switching to free cash flow for a minute because I thought that was a bright spot in the quarter.
Cash flow up pretty good excluding that $20 million payment. So I want to know if you could expand on Patrick's opening remarks.
Discuss more about that second half how it works for you know just more specifically in terms of inventories receivables and payables, how should we expect working capital be comparable source of cash in both Q3 in Q4 is that more of the bulk of it in Q3.
Well, let me start and Patrick you want to chime in here, but.
Clearly the push in the organization is to right size, our inventory with the new demand levels, a new production levels and I believe we believe we've seen we've reviewed during our strategic review that there is plenty of opportunity throughout our supply chain, including raw materials works.
And process and even some finished goods.
You know as we took such quick actions on the cost and restructuring and the organizational restructuring. There's some inventory that unfortunately is on the water. It's in the pipeline, it's being delivered and it takes a little time to slow that down so we fully see.
The second half of the year being a spores from working capital.
And quite honestly, it's a bit priority on especially around inventory.
Yes, the anything I would add sort of just to echo Nick ready, we took the pain on the payables in Q2. So they came back very quickly to reflect the low receipts of materials raw materials coming in.
Receivables, obviously a bit of a double edged sword that came down or these cash I mean, ultimately we want to grow revenue again and turned that around so we probably had a lot of that benefit.
But it really is inventory as Nick said, we have a huge opportunity.
The second half of the yes should be stronger than what we've seen year to date yeah.
Thanks to both of you appreciate it.
Your next question.
Your next question comes from ship Sheila Kahyaoglu from Jefferies. Your line is open.
Hey, Good morning, guys, Patrick you talked about double digit margins being hard to achieve 2020 at versus your previous expectations. You know clearly mix is a big impact with carbon fiber can you talk about the trajectory of this and how we should expect about 10 proof.
Well I'm not going to get into specific numbers, but clearly.
We have greater in science and you can have perfect visibility upfront, but I think the magnitude of the impact from our customers in the market dynamics with stronger than we initially expected.
And yes, the bulk use in the supply chain will launch the de stocking and so we're going to push as hard as we can in twentytwenty.
Clearly the double digit is going to be a huge challenge as we go forward, we're going to drive ourselves back into double digits, and we should actually see very strong incrementals. Once we get the topline growth now clearly the uncertainty is around that topline, but once that emerges with all the cost aligned.
The right sizing that we're doing we're putting in the right foundation will be in a very strong position to not only get into the low double digits, but push ourselves back up to two levels. We saw previously.
And just on the mix impact a little bit more you know given obviously wide bodies have more carbon fiber is that where we should be looking to see the growth start up and that's where we could see margins improving.
I mean, we provide carbon fiber broadly across the spectrum of programs I mean, yes. The athree hundred 50 is clearly the largest single program and that has an impact but the narrow bodies through the engines through the next sells the casings and second restructure pre price all say pool carbon fiber.
So generally as we see the carbon fiber pre pryke pull again on the way back up and that that will drive strong incremental margin that mix.
Just on the way down and it will help us significantly on the way back up.
Thank you so much.
Your next question comes from Myles Walton from Yes. Your line is open.
Hi, Good morning again this is new if at all on per Myles I. Just wanted to go back to perhaps you mentioned that the first quarter here, especially shutdown. The math you did restart in Twoq you should can you could argue producing because you had some peers out there will be says that they're not shipping anything on the Max until some point next year.
Now I will say Swiss shipping at low levels. It is still pretty low levels, but we all shipping small quantities of material.
Okay, and then also you've talked in the past about the the Fungibility I guess, specifically I think of the carbon fiber or have you had any let's say a.
Worthwhile conversations with customers, whether they be industrial or anywhere else or is it sort of consider shutdown a large what part of it. So just curious how those.
Having conversations going.
Yeah, I mean, a lot of our assay is off fungible, but it takes time. So we absolutely are having conversations with customers about industrial applications strong carbon fiber.
Applications for our pre Preg. Another source is where we can get some short term wins.
It doesn't happen overnight, but we can redirect the vast majority of our company said sort of sex segment lines and we will do that.
We're not going to chase commodity low margin and with no value add and we still going to stick to our principles. We want to provide some value we may be a little bit more flexible around that but if we can bringing some industrial recreation automotive amputation neutralize some of our carbon.
Fiber, so respectable margins, but definitely going to do that and how those conversations on taking place.
Okay. Thank you very much.
Your next question comes from Phil Gibbs from Keybanc Capital. Your line is open.
Thanks, very much good morning.
Good morning.
The labor reductions targeted to be about 30%.
On the cost side, how much of that you think you got in the second quarter in and how is the rest going to be phase them.
Yeah, I mean, I think we called out I mean in total cost in pure cost, we will probably very close to sort of 25, 30% wherein not running these things do take time, we called out the 1600 heads, but then you combine that with furloughs and salary reduction.
Contemporary salary reductions and benefit costs on short time, working so as we sort of worked our way through the course, so it makes no clicking alliance, which we played as many of those causes we could too to improve our cost base.
So the permanent 1600 hedge those it clearly in place.
As we indicated in the script, we're continuing to work on further.
Permanent restructuring some of that takes longer because of rules and regulations in in other geographies, especially around Europe, and we will continue to push but will combine that again with more furloughs in short time working in Someones is so.
Hey, I'm not going to be precise timing is hard to be exactly precise, but we got a large chunk of saving in Q2 way going to see that again in Q3 and as we get towards the end of the yeah.
We'll have a large portion of that Don but I would flag some of the European progress could even stretch into next year.
Okay I appreciate that and then how much severance cash costs should we expect over the next couple of quarters associated with these actions.
So again I'm not going to call on a specific number the vast bulk of the $13 million.
So the non five centers that number was really severance related.
This quarter it will be less than that in the second half, but they will be the severance costs that comes right.
Thank you and then last question just on the wind energy market can you talk a little bit about these you know these outsourcing issues and how.
How that impacts you in the in the short run and long run it seems like.
New revelation, just trying to understand it thanks.
Yeah, I mean, what were starting to see I mean, the energy market is highly competitive if the price of oil is always the sort of increasing that pressure wind energy is trying to compete and what we've seen this sort of emerge over some time, but perhaps is getting even stronger now.
The wind energy menu, Frank Troise, it just having to really push and focus on cost and they're doing everything they can and we're seeing an increasing shift to these outsourced blades.
And so really wages flagging that that market is going to have increasing challenges.
As we see it going forward, we're going to try to be as competitive as we can as always drive our efficiencies, but we do see that market and cost pressures.
Continuing.
[noise]. Thank you.
Your next question comes from Noah Poponak from Goldman Sachs. Your line is open.
Hi, good morning, everyone.
Good morning, all morning.
The the release.
But youre going to temporarily suspend.
Some operations at a few sites during the third quarter.
And I think it states doing that too to align production and inventory. So the I read that reads of incrementally more inventory de stocking in the third quarter versus second quarter.
I have that correct or is it.
A similar rate of that action in Threeq reversed or if you.
So.
I would say couple of things de stocking and.
Idling assets within our plants, we've been doing that going back into the end of March April timeframe based on customer customer demand down where did the most sense for us to allocate resources to.
What what we're really pointed out in the earnings release is the carbon fiber assets that were idling.
Our above and beyond what we had idled earlier in the quarter and that's going to continue along with seasonality that we typically see in Europe.
In the third quarter timeframe, so we do see significant pressure.
And expect more de stocking in the third quarter.
Okay, Yeah, so but to see if your normal seasonality if the if the year over year rate of decline in aerospace revenues was the theme in the third quarter is the second quarter. The absolute dollars what would be a bit lower from that should I think about the rate of decline as well also being.
A larger rate of decline in Threeq versus Twoq.
I don't think so I think we've made a circuit adjustment in the second quarter, we moved quickly.
Patrick May want to add some color there but.
I don't see a dramatic change.
Okay. I think the magnitude is the underlying decline is probably similar I mean, plus or minus but then you need to layer on seasonality. So that's the difference as Nick said that we would make probably.
Right.
Alan year over year, roughly give or take roughly the same amount, but and then that would make it down a little bit sequentially.
Yes, you could say that directionally.
The Vicki.
The items that made the space and defense segment growth rate.
The negative in the quarter.
Are those items that last for a few quarters moving forward or was that pretty one one quarter timing specific.
I I [laughter], how to be precise on that no I mean fundamentally we remain optimistic and I think we used the word bullish around spacing defense, we see that market sector holding out for us.
The U.S. in particular is remaining strong the softness within Europe. Some of it was pandemic some of its going to be budgetary pressures, but overall I think we really see is timing fundamentally the build rates in space and defense. We don't see is shifting all coming down so there maybe a bit of a bump.
From quarter to quarter this year, maybe a little bit noisy, but we still see the overall performance this year to be robust.
And so as I say, we remain optimistic said I don't think I would point to anything specific in Europe or elsewhere, and if anything we see robustness in the U.S., which is very encouraging and medium term a lot of new programs, which Nick I alluded to I think on the first question.
Got it.
Just last one for me Patrick on the margin question.
If I gave you the hypothetical that Boeing and Airbus did not need to cut production rates further anymore from from all of US They were able to hold what they've announced so far in that hypothetical would you be able to get the operating margin back into the double digits in 2021.
Our objective is definitely to drive ourselves to that I think your questions a little bit specific even if hypothetical but given some top line uncertainty in some top line growth.
We will align our cost to drive to double digits and keep going up now.
Okay. Thank you.
Your next question comes from John Mcnulty from BMO capital markets. Your line is open.
Yeah. Good morning, Thanks for taking my question, maybe just one last question on the cash flow side. So normally second half is 70% to 80% or so of your of your free cash in any given year. I know this is a is a pretty pretty extreme year. So certainly not normal but I guess is that would that be are relatively decent metric to <unk>.
To think about in terms of a in terms of the rest of the years cash flow figuring that you're going to have incremental you're going to have more on the inventory help you gonna have maybe a little bit less on the earnings help how should we think about that.
I think directionally, you're in the Ryan space I mean, Q2, we were able to drive.
So what we felt was very good cash numbers, obviously, we don't have the topline EBIT dollar is under pressure.
But yes, we have a lot of opportunity with inventory and the second half of the yet.
We will be a lot stronger than the first half of the yeah yeah.
Great. Thanks for the color.
Your next question comes from Paretosh Misra from Berenberg. Your line is open.
Thank you good morning, gardening, Patrick correct. So I just wanted to go back is this a new revenue opportunities that you're exploring a file your products for carbon fiber.
Opportunities outside commercial aerospace.
There are you looking to gain market share from another composite producer or some competitor or these are currently applications, which are basically metal base.
Some of their material, where you just looking to grow the use of composite like is it more a substitution story our market share gain story.
I'd say, it's predominantly new opportunities new applications, requiring new materials. Some of that may be displacement of prior models or others, but you know some of the drone some of the new unmanned vehicles.
Some of the technical opportunities, we're seeing in industrial are for new models, new innovative solutions going forward. So predominantly new opportunities. Although there are some areas, where we have enhanced technology from my call.
Cost an overall performance standpoint that we do think has some opportunity to displace existing materials.
[noise], Thanks, and maybe just to follow up on the FX impact just wondering.
You have tried to quantify what kind of headwind on operating margins you might see in Q3 from FX based on current.
Okay great.
I I mean, my thing, we called out about 40, 30 40 basis points.
Today, I don't expect it to be significantly different in the second half of the yet it will be a continued headwind.
Just based on the hedges, we have in place versus 29 team, but I don't see it becoming significant.
Got it thanks, guys good luck that everything.
Thank you.
Your next question comes from Pete Skibitski from Alembic Global Advisors. Your line is open.
Hey, good morning, guys.
I think it was on the last call you talked about in engineered products. Some of the less complex work at the Kent, Washington site. It kinda migrating to a lower cost suppliers and obviously, we kinda saw sales down pretty sharply into Q there within within that segment. So I'm just trying to understand how much of that was impacted that work migraine.
Moving to other suppliers versus how much was underlying market softness.
Yeah. So.
Yes, we frankly don't because that agreement that movement in the market. So as you say the lower cost so supply as if it's going to take place most of what we sold to be honest in the second quarter was pandemic and general build rate.
If anything what that's going to do is soften that transition for from a headline revenue perspective in that we've seen a launch reduction already and so.
As the under the some of the underlying business comes back. We just went dead is as much coming back because of that transition taking place at the same time so.
I would say largely what we've seen to date is not that transition, but the step down we saw an engineered products as I say is probably going to smoothly transition where as we expected, it's perhaps be more of a steps.
At certain points in time.
Okay. Okay.
Last one for me and the industrial markets. So you've been down pretty good for three straight quarters, now and industrial and I'm just trying to get a feel obviously my guess is you'd expect another double digit decline in the third quarter.
Comps easier as you head into your fourth quarter do you expect to see you know.
Maybe an inflection up in the fourth quarter and industrial or maybe because of this incremental when headwind year to see softness in the 2021 there.
Yes.
Avoiding given any guidance simply because of.
All be uncertainty in the markets on the adjustments being done an interest to be consistent so.
We're working closely with our key customers on new opportunities, we're working closely with them on rightsizing their supply chain. So I don't want to give then get into giving any direction on what we expect to see quarter over quarter from a sales perspective.
Okay, Okay fair enough. Thanks, guys.
Thank you.
Your last question will come from Ron Epstein from Bank of America. Your line is open.
Hey, good morning, guys.
Just maybe broadly.
The whole call there has been a lot of focus on cost cutting and so on and so forth from your seat how do you know what you've cut deep enough right I mean, because ultimately things will turn right.
You know, it's it seems reasonably dark right now, but depend on a go past will be there'll be some sort of fixed for all this so how do your sure that you just don't cut too far that when things do get better you have it cut into bone as they say probably so how do you think about that.
So you know we stay aligned for one thing we aligned with our customers.
Their programs on advanced technology for next generation airplanes.
Components engines in the cells.
They may have slimmed down with respect to what the priorities are but they haven't stopped those initiatives nor have we.
So we we continue to stay very close to our customers. We continue to look at how we're allocating our challenges throughout the business I'm working with our key to make sure that were not cutting into the bone and we we Patrick and I spend a large portion.
One of our time.
Doing just that and it's not only in arent you keep in mind some of our assets.
Through training the skill set we need and certain assets can take up to a year. So the fact that we have fungible assets, we can move around allocate and optimize our footprint and our cost structure to take into consideration customer demand, but also to take into consideration.
How do we maintain the appropriate level of skilled resources throughout the organization to capitalize on the growth when the growth comes back. So it's not just arent you arent. She is big no doubt what is throughout the entire organization and then we monitor it real time, if we need to cut.
Another couple of percent or if we need to add back a couple of percent, we adjust daily and weekly.
Gotcha Gotcha, and then maybe just one quick sort of following up in the prepared remarks for their called you guys mentioned that the there was more carbon fiber in the channel and then you had anticipated.
What was the cost for that is it just your visibilities only so far or is it just that things have been worse for longer than maybe everybody was anticipated.
I I think it's it starts with.
The lead times and the complexity and the vastness of the supply chain itself and you can look pick a program you might have 60 shipped to 60 ship twos and everybody's at a different point each delivering their piece of the of the puzzle whether it's an engine fan blade or a flat.
Shroud or primary structure, so supply chain is very complex I.
I think our best visibility is clearly with Boeing and Airbus and what they're doing internally.
Less so when you start going down to the tier ones.
Even though we work with them.
We don't have perfect visibility in it and again I would I would also say you've got the combination of visibility as one factor, but you also have the factors as production rates are going down that supply chain continues to get squeezed even more.
And we've seen a combination of both.
Gotcha Gotcha, alright, thank you very much.
Thanks, Ron.
We are at a time for questions. Today. This will conclude today's conference call. Thank you for your participation you may now disconnect.
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