Q3 2022 Hexcel Corp Earnings Call
Ladies and gentlemen, thank you for standing by my name is Brent and I will.
Your conference operator today.
Time, I would like to welcome everyone to the shell third quarter 2022 earnings conference call.
All lines have been placed on mute to prevent any background noise after the.
The speaker's remarks, there will be a question and answer session.
Last quick question not that time simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question again Press Star one. Thank you. It's now my pleasure to turn the call over to the Chief Financial Officer, Mr. Patrick Wunderlich, Sir Please go.
Ahead.
Thank you Brian .
Good morning, everyone welcome to Hexcel Corporation's third quarter 2022 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.
The statements contained in this call may constitute forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.
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 last Night's news 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 it cannot be recorded or rebroadcast without our express permission.
Participation on this call constitutes your consent to that request.
With me today are mixed manage our chairman CEO and president and kind of build out our vice president of Investor Relations.
The purpose of the call is to review our third quarter 2022 results detailed in our news release issued yesterday.
Now, let me turn the call over to Nick.
Yeah.
Thanks, Patrick.
Everyone and thank you for joining us today as we share our third quarter 2022 results, which reflects strong incremental margin performance and another robust up for the whole year of progress as we move beyond the pandemic.
Our key challenge today is meeting the strong market demand in front of us.
Our aerospace customers are continuing to increase build rates as orders for new claims grow to meet airline requirements for capacity and modern fuel efficient aircraft.
Passenger numbers are growing back rapidly and in many parts of the world are back to pre pandemic levels and even higher as pent up demand Blake's both personal and business Brad.
The poll for Hexcel lightweight advanced composites remains strong in all of our markets and by all indicators will strengthen even more in 2023.
I am confident that we will be ready to meet that challenge.
Exxon has a sustainable competitive advantage.
Excellent customer relationships and leading sole source positions in key markets with high barriers to entry.
With our innovative technology and the broadest aerospace composite product portfolio in the industry. There is no other company in our advanced materials space that is better positioned to take advantage of growth opportunities ahead that helps out.
In addition to inflationary headwinds and supply chain constraints over the past several months the third quarter reflects some seasonal customer production slowing notably in Europe .
However, while in August slowdown, it's typical for European Aerospace and defense that slowing in our sales was amplified this year by our need to train and onboard a larger number of new hires in the mall.
With time Indulgent training, our new helps all employees won't increase their experience and efficiency and allow us to return productivity and throughput levels, we have historically achieved and more.
While these challenges are real we won't let them distract us from our operational excellence commitment to.
Streamline processes and drive productivity and work efficiently.
Our objective remains unchanged to deliver perfect customer performance with respect to quality on time delivery and value.
Now, let's turn to some specifics reported in our earnings release last night.
Third quarter sales of almost $365 million were more than 12% higher in constant currency as compared to Q3 2021.
Third quarter adjusted diluted EPS was <unk> 33 cents compared to <unk> since last year.
We were full aerospace sales of about $209 million were up 26.5% in constant currency led by growth in the Airbus <unk> hundred 50, and <unk> hundred 20 Neo programs.
So as the market recovers hexcel benefits from the continued penetration of lightweight composite materials as well as our relentless commitment interface with our customers on new materials and processes for next generation programs.
Our commercial aerospace customers continue to forecast growth in both narrow body and wide body programs, where <unk> has strong positions.
<unk> robust domestic passenger demand and growing confidence in the return of international travel.
This is Jess and regional aircraft sales increased more than 69% in the third quarter of 2022 compared to Q3 of 2021.
As we discussed last quarter. This is just represent a great opportunity for up sell over the next few years with launches of new composite rich business Jets.
With content on some of the larger business jets nearing that of narrow bodies.
See nothing but opportunity for greater penetration of the advanced composite materials and <unk>.
The potential for more composite wings likely to solve Falcon X and noise, reducing advanced composites that are unique to <unk> portfolio.
Turning to space and defense.
Third quarter sales of about $109 million were essentially flat in constant currency. However.
However, key programs remained strong and year to date sales in this market are up almost 5% in constant currency led by the CH 53, K heavy lift helicopter.
Well, it's a civil rotorcraft satellites launchers and rocket motors.
Demand for fiber aircraft, such as the F 35, Raphael and even the eurofighter are strong and growing reflecting strengthening defense budgets around the world.
Our expectation is that space and defense will grow robustly as build rates increase and we continue to win positions on existing and new platforms.
Looking forward, we are waiting keenly to hear a decision on the new floor Rotorcraft and then at a later date the decision for the farmer watercraft.
<unk> is ready to support both of these exciting lead generation programs with a lightweight composite technology, which in time will further strengthen our space and defense sales.
Industrial sales declined more than 8% in constant currencies due to lower wind energy sales.
Offsetting the decline in wind energy was continued growth in other industrial markets, including high end automotive Marine and recreation.
During the quarter, our hubs supply carbon fiber reinforced epoxy <unk> products receive type approval from Euro pruritus, where which is a world leader in testing inspection and certification services.
As a result, we anticipate increased sales of our composite materials, especially in the manufacture of mass and other large structural components for wind assisted ship propulsion.
Again, our lightweight advanced composites are playing an integral role in enabling more sustainable fuel efficient transportation.
That is aerospace automotive or marine in every case, helping to improve efficiency and reduce emissions.
I'd like to take a moment to share that earlier. This month, our leadership team spent a whole day with <unk> R&D team to review progress toward continued innovations in both our products and processes.
Our R&D team has a relentless focus on stronger and lighter composite solutions as well as maximizing the efficiency of our production processes.
While I can't share specifics on their work I can tell you that our scientists are fully dedicated to ensuring that hutzell proposed the development of advanced lightweight composite solutions to meet our customers future demands.
Not only do they continue to advance carbon fiber and honeycomb core technology for next generation programs Theyre, continuing our focus toward end of life and more sustainable solutions.
As a reminder, some of our U S. RMT team are moving their work into our flagship research and Technology Center in Salt Lake City early in 2023, and I'll look forward to sharing their technological breakthroughs with you in the future.
Year to date total hetzel sales are up almost 22% year over year in constant currency and EPS of <unk> 88 cents compared to 11. Since this time last year, all of which reflect our strong performance and forward momentum as we enter the final quarter of 2022.
Now, let me turn it over to Patrick to provide more details on the logos.
Thank you Nate.
As a reminder, the majority of our sales is denominated in dollars. However, our cost base 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 and the pound our sales translate lower while our costs also translate lower leading to a net benefit to our margins.
Conversely, a weak dollar is a headwind to our financial results. We had to this currency exposure over a 10 quarter horizon to protect our operating income.
Continued strengthening of the dollar versus the euro and the pound had a negative year over year impact third quarter 2022 reported sales of approximately $9 million with the greatest impact being on our industrial business.
Conversely, the strong dollar is positive for our margins as a reminder of the year over year sales comparisons I will provide our in constant currency, which thereby removes the foreign exchange impact to sales.
Turning to our three markets commercial aerospace represented approximately 57% of total third quarter sales.
Third quarter commercial aerospace sales of $209 $1 million increased 26, 5% compared to the third quarter of 2021 from Hyatt Airbus <unk> hundred 20, neo production rates and from growth in the Airbus <unk> hundred 50 program.
Third quarter sales have historically been soft.
In the second quarter and the OEM production slows due to summer holidays, particularly in Europe . This was a consistent trend back Sal leading into the pandemic.
<unk> hex outside of again this year.
Space and defense represented 30% of third quarter sales and totaled $108 $9 million, which was essentially unchanged from the same period in 2021.
It was a quarter of relatively small puts and takes.
Yeah, It's 53, K and legacy I E 64 increased year over year, while F 35, Black Hawk and space were a bit softer.
Industrial comprised 13% of third quarter 2022 sales industrial sales totaled $47 decreasing eight 4% compared to the third quarter of 2021.
While automotive recreation and other industrial markets increased year over year, the growth did not offset lower wind energy sales.
Wind energy comprised around 20% of third quarter industrial sales.
On a consolidated basis gross margin for the third quarter was 22, 4% compared to 19, 8% in the third quarter of 2021 with the improvement reflecting operating leverage.
Inflationary pressures continue to remain a headwind, particularly with select raw materials freight costs consumables, such as packaging and higher energy costs.
Raw materials are the largest component of our cost of sales followed by labor.
As I've previously referenced many of our large raw material purchases are protected by long term contracts or hedges that are designed to layer in pricing changes overtime.
Depreciation is our third highest cost category, followed by utility costs, which represent roughly a mid single digit percentage of total cost of sales.
As a percentage of sales selling general and administrative administrative expenses and R&D expenses were 11, 1% in the current quarter compared to 12, 7% in the third quarter of 2021, we.
We continue to tightly control costs as this decreasing percentage of sales demonstrate.
Adjusted operating income in the third quarter was $41 2 million or 11, 3% of sales.
The year over year impact of exchange rates in the third quarter was favorable by approximately 50 basis points.
Now turning to our two segments. The composite materials segment represented 80% of our total sales and generated a 13, 5% adjusted operating margin strengthening on high capacity utilization.
The adjusted operating margin in the comparable period.
Last year was 11, 4%.
The engineered products segment, which is comprised of our structures and engineered core businesses represented 20% of total sales and generated an eight 3% adjusted operating margin.
The adjusted operating margin in the comparable prior year period was eight 1%.
I would also like to note that the year to date adjusted operating margin for engineered products is now 11, 5% compared to seven 1% for the same period in 2021 on a similar level of sales, which reflects our move toward higher value add programs in this part of our business.
The effective tax rate for the third quarter of 2022 was 21, 4%, which included a discrete tax charge of $1 $3 million.
Resulting from the true up of a deferred tax item.
So the 2022 financial year, we are now estimating a tax rate of approximately 22% by 1% lower than previously estimated.
Play due to various tax credits being larger than expected.
Net cash provided by operating activities was $56 $4 million.
First nine months of 2022 compared to $64 2 million for the first nine months of 2021.
Working capital was a cash use of $150 million year to date in 2022 compared to a cash use of $46 million for the first nine months of 2021.
Working capital has increased to support growing sales and reflects a higher inventory buffer or safety stock to help mitigate some of the global logistics challenges and constrained supply chains.
Capital expenditures on an accrual basis were $49 1 million for the first nine months of 2022 compared to $14 $3 million in the prior year period.
The increase in capital expenditures reflects higher maintenance capex as our capacity utilization expands combined with growth capex, including our previously announced production expansion in Morocco to support commercial aerospace and defense markets as well as the construction of a new research and technology Innovation Center in Salt Lake.
Utah to support next generation aircraft and future industrial applications.
Free cash flow for the first nine months of 2022 with negative $1 $9 million compared to a positive $49 $2 million in the comparable prior year period.
The decision to hold high levels of inventory and particularly raw materials has been the principal headwind to free cash flow generation as I cautioned last quarter.
We continued to tightly manage our debt levels, having now repaid over $300 million of debt over the last three years.
This lower level of debt provides <unk>, a strong foundation as we evaluate future capital allocations.
We did not repurchase any common stock during the third quarter of 2022, the remaining authorization under the share repurchase program at September 32022 with $217 million.
The board of directors declared a <unk> <unk> quarterly dividend yesterday payable to stockholders of record as of November four with a payment date of November 14th.
Before turning the call back to Nick I would like to review the updated guidance.
And in the earnings release issued yesterday.
We narrowed our 2022 sales guidance to a range of 153 billion to $1 $601 billion.
Note that foreign exchange is estimated to be approximately a $35 million headwind to our 2022 sales number assuming exchange rates remain around current levels for the remainder of the year.
We have narrowed our adjusted diluted earnings per share guidance to a range of $1 12 to.
The $1 24.
<unk> continued strong execution, we are benefiting from operating leverage while managing inflationary cost pressures.
We are forecasting strong free cash flow generation in the fourth quarter of 2022. However, we do not expect to reach the prior guidance of greater than $145 million, primarily due to higher raw material inventory levels.
We purposefully increased our safety stock.
We now expect to be in the range of $100 million of free cash flow for the year.
Full constant accrual capital expenditures of approximately $75 million.
In fiscal year 2022 is unchanged.
The underlying effective tax rate estimate for fiscal year 2022 is now reduced to 22% from 23% previously.
With that let me turn the call back to Nick.
Sure.
Thanks, Patrick.
One of the biggest challenges we face is ensuring that we meet current and forecasted demand.
We will continue to drive productivity and efficiency and in the near term, we're putting additional focus on training our workforce to deliver the output volume required while always driving operational excellence.
Our commercial aerospace customers are ramping up almost every platform our space and defense customers are seeing robust and growing demand and value add industrial opportunities continue to emerge.
We expect this strong growth will continue in the years ahead, especially as air travel returns to pre pandemic levels globally, and all of our markets increasingly turned to the Basel that lightweight strong and durable advanced composites provide as the world's strides toward lower emission transportation alternatives.
Our hexcel team has determined and ready to take full advantage of the significant growth opportunities that lie ahead.
As always our focus remains on delivering excellence to our customers and value to our shareholders.
Brian we're now ready to take questions.
At this time I would like to remind everyone in order to ask a question press star followed by the number one on your telephone keypad.
In the interest of time, please limit yourself to one question and one follow up question. Your first question comes from the line of Ken Herbert with RBC. Your line is open.
Okay.
Yes, hi, good morning, Nick.
Nick and Patrick.
Good morning, Ken.
Hey, I just wanted to first ask around the change in the free cash flow guide for the full year I could appreciate the incremental investments in working capital.
How do you view that may be working down what do you need to see and obviously your supply chain or in the industry to get comfortable start to take to release. Some of this working capital and what would you be what would be your expectations on timing around that.
Yeah, Hi, Ken So I mean, it's a very deliberate decision that we've taken as many companies are taking really faced with the sort of global supply chain constraints longer lead times shifting instead of four weeks eight weeks or six weeks, it's 12 weeks.
So faced with that uncertainty and with really great demand that we've got in front of US we want to maximize our sales. So we deliberately chose to build our inventory levels and that is sort of putting this down to that range of about $100 million.
Really it's a timing thing I mean, we would have grown into that level of inventory over time anyway. So arguably back cash flow impacts, we're taking in 2022 rather than in the future. So if anything is going to strengthen our free cash flow performance in 2023 and beyond so.
As sales grow our working capital levels with Nuomi grow, but the way I would put it we've accelerated some of that as a buffer.
Anticipating the strong demand in front of us.
<unk> into 'twenty, two so we won't have that again in 'twenty three.
That's helpful and just as a follow up as you think about sort of this de risking ideally through the investments is this more to do with perhaps what youre seeing in Europe and in the risk of incremental disruptions there or is there any sort of geographic or other angle. We should think about it on this I think it is very broad Ken <unk>.
That is a factor, but as a sort of the extended China Covid lockdown as they still emerging out of the pandemic as is the industrial ramp up around the world I think it's a multi factor impact and it's really just being prudent and smart we believe in the face of that to maximize our output in the period.
Head.
Great. Thanks, Patrick.
Your next question comes from the line of Rob.
Rob Spring Iron with Melius Research your line is open.
Hey, good morning, Nick and Patrick just I want to make sure im not misunderstanding the pressure on sales.
The decrease in.
In combination with the with.
The lower cash flow could you talk a little bit about the intake of product from Boeing you met you called out the <unk> hundred 20, <unk> hundred 50, and you called out Biz jet, but as Boeing taking product at your expected rate.
So ill.
I'll take that Rob.
With respect to Boeing if we if we look at the specific programs the bank.
<unk> has been ramping up throughout the year and we're aligned with Boeing.
The rates of scope of authority.
Certainly ready to go higher or more supply chain issues ease and when they go up.
<unk> downstream.
Maybe 38 with respect to the 77.
It's a little different story, it's been very slow very low rates.
I think our third quarter actually get just a little bit.
Again, Boeing has started deliveries back up but that hasnt really translated into production demand for us which will in the coming quarter.
<unk> in quarters ahead.
And there is an expectation there that Boeing will ramp up back to probably starting with a number of our five maybe mid to late next year after they burn off some of the.
Inventory.
Based on the rework, that's taking place as we speak.
We're pretty much.
As expected.
Per our plan and no big surprises from Boeing or Airbus side.
Okay. So I just wanted to make sure that some of this extra inventory I mean, Patrick you were very clear, it's deliberate preparing for the future, but I thought some of it might be Boeing.
Linda.
It's really not it's really raw materials that are fungible across all of our <unk>.
Customers and product ranges and again, it's just.
It's basically protection.
I think Patrick mentioned, it we actually had a stronger demand than we produce two in the third quarter.
And part of that was the supply chain disruptions and.
Even though it appears to be stabilizing from our perspective.
It's still not back to consistency, where it was pre pandemic, where our plants can run efficiently.
And then with respect to the labor and training, bringing new shifts on bringing our assets bought online. That's just taken more time and we're seeing it improve and it certainly will improve greatly and more in Q4 and throughout next year.
Okay, and then just as the follow up in the past you've talked about getting back to the mid teens plus operating margins when sales hit that 181 $9 billion level, but there's a lot going on we have inflation is a headwind FX potentially a tailwind so does that.
Algorithm hold true going forward or has it changed somewhat.
Well I think Rob you pointed out that a lot of things have changed with respect to inflation and labor.
But I'm not going to say, we're giving up on that objective to get to the mid teens and we're in the 1819 revenue range.
We still.
We're still driving for that.
It's not out of region.
Okay. Thank you.
Thank you.
Your next question comes from the line of Mike Sison with Wells Fargo. Your line is open.
Hey, guys.
Nice quarter there.
Hey, Anthony in terms of the.
The outlook for industrial as you if you think about 2023.
I think there's going to be a downturn in your business a little bit different with wind. So any thoughts of how I guess resistance the business could be as we head into 'twenty three.
Yeah.
Yeah.
Mike.
Thanks for the question.
It's mixed recreation remains very strong.
Automotive remains strong and you have to remember that in <unk>.
To mainstream commodity automotive around the high end.
Specialized products that are typically less affected by slowdowns in the economy and recession. So we don't see a big change there.
We're actually being very selective with pricing in that market because telecom fiber is very tight and we're selectively choosing what markets, we're going to continue to pursue and which markets we're going to.
Pricing and may be pulled back a little bit.
The win story wind tend to change direction in the U S for us.
It's just migrated to a commodity.
Type blade manufacturing and technology, which we had no interest to pursue and so we think the industrial segment will hold up well.
Given the differentiation in the products and the platforms that we pursue.
Great and then just a quick follow up on commercial aerospace you know the fourth quarter, it's going to be.
Incremental step up from the prior quarters, and if you think about the build rates heading into 'twenty three.
How much growth do you need to sort of plan for in 'twenty three.
As you ramp up the sales force and new workers and such thanks.
Well clearly we're expecting pretty.
Pretty strong growth in 2023, we're still rolling up the plan, but as we said in the comments.
Many of the platforms are in the process.
Renting up certainly Airbus is ramping up strongly.
And we.
We see nice growth, it's a little early for us to guide.
Mike but.
We're in the process of recruiting I can say.
One of the first times in my career Ive seen our headcount.
<unk>.
Go ahead of our planned law.
And and that's an indication of our training and trying to get prepared.
And making sure our workforce is prepared for the growth not only in Q4, but in 2023. So we think we're going to enter the year very strong.
And we're clearly going to have strong demand and strong growth.
Great. Thank you.
Thank you Mike.
Your next question comes from the line of Ron Epstein with Bank of America. Your line is open.
Hey, excuse me good.
Good morning, Ron kind of digging down more on.
Those growth numbers.
As we think about going into next year I mean, the consensus has got.
Reasonable growth for you guys.
How should we think about that in the backdrop of a potentially slowing economy. It seems like the freighter markets got a couple of cracks in it.
I guess.
Another way of getting that this has been when do you think 7878 production could get back to like a good healthy number like a six or seven per months.
I think everybody is just trying to struggling struggling just trying to.
Figure out how you can get to the growth that you said youre going to get to.
Yeah, I mean, we're confident I mean <unk>.
I mean, I'll split Boeing and Airbus I mean, if I start with Boeing I mean, the 787 is clearly I mean, I've done about six or seven but its certainly positive going up to five towards the back end of next year from a very low rate today. So that's nice growth.
The Max is stabilizing and as Nick alluded to Boeing will look for the opportunity to push that out as and when they can.
And then we have Airbus I mean, the $3 50 is now very solid at five is going to move to six at some point next year and the $3 20 is rapidly moving up to sort of 65 again early 2024. So all of that is very solid you have got a solid foundation in space and defense and increasing monetary budgets.
You've got business jet, which may not go out I mean, they're not going to keep going up 70% quarter on quarter, but it's a great market for us and it is going to keep growing so all of that gives us confidence.
In solid growth going into 2023 and beyond now when the build rates of the wide bodies move up on solely to the high single digits.
Watching but we're encouraged by the growth in international travel International Passion Pat.
Passenger demand and freight traffic is not going to stall forever I mean, I hear what youre, saying I don't think that big cracks, but overall, we're confident on the narrow bodies. We're confident in wide bodies are going to come back on that based on international travel that's not just because we want said and so as Nick said, we're bringing in people we're training them up.
We've brought enrollment cereals to be ready for this demand that quite honestly, we're struggling to meet right now we're expecting a solid fourth quarter and we are looking positively at 2023.
Got you got you and then maybe one follow on to that maybe back to the labor point because this is something we've heard consistently across many different companies.
In that sector that getting labor, it's just been tough skilled labor getting labor trained up.
How is that going for you guys.
It's a different regionally.
Or not.
I'd say, we've seen that improve over time.
I would say nine months ago, it was a little tougher than it is.
I think we've changed and tweaked our processes.
Now, we're going after and identifying talent.
So all in all we're bringing in very strong people.
And the challenge is getting them trained on our production loans, whether it's fiber related or a precursor related with some of those are pretty skilled positions.
With very good labor wages.
It just takes time for us to do that so I would say.
Finding the people, it's not a problem.
Getting them trained.
<unk> back to where our expectations are let's just take them some time.
Gotcha. Thank you.
Your next question comes from the line of Myles Walton with Wolfe Research. Your line is open.
Good morning, I was hoping to just touch on the seasonality versus the head count.
Stresses to the topline in the quarter, you, obviously anticipated some of the seasonality, but I'm just curious if you could quantify.
Sort of the impact of the lower head count or the lower efficiency.
Of work being done and then Nick can you actually put numbers to your head count goals. I think you were at almost 7000 in 2019 and you enter 'twenty. One just below 5000. So just how do we build back up to 7000 over the next few years.
Well.
As we approach $2 $5 billion, we certainly well Myles.
That's all of our goals here.
To get specific on where we are I'd say, both in Europe and the U S.
We brought in probably just less than 100 overall plan to give you a little color.
Some of those skill physicians trained and in place and again to Patrick's point on our 2020 fully projections, we'll grow into that head count very very quickly. So that's just good business management operational management to hold a little inventory to make sure we can.
Can protect our customers because the demand is strong and and just to say it again, we did not ship the demand that we had in front of us in Q3.
I would say we offered our customers negatively from slowing their lines down we did not do that but we definitely caused a shrinkage of that supply chain and we've got to replenish that and that's what we're going to do in Q4 and beyond so.
Again.
Sure.
Yeah.
We're just.
Right.
Loans, bringing shifts in getting the assets going getting our fiber volumes.
All of them running 100% across the board both in the U S and Europe .
From a low point in the pandemic, where that was the largest area, where we reduced our head count and shutdown our assets miles salt, Okay again, it drives a big portion of our overall.
And certainly there is a focus for us going forward.
And Patrick in the third quarter corporate costs was there a one time reversal of any size and also sort of maybe just the EPS walk how much is lower corporate cost as a benefit in that in that new EPS range.
Yeah, I mean, obviously corporate costs are always a bit lumpy miles I mean, if you look at yesterday position I think we're sort of over $10 million, a month, which is where I would expect it to be I think this year Q1 was probably a little bit heavy Q3, as you're obviously alluding to with a little bit lines, we had a sort of what I would call a year.
Today realignment cleanup of thing buying Florida health care insurance and workers' comp.
I think there was one severance reverse so.
But I think I always try to look at the year to date positions because if you get too hung up on the quarters.
Can look a little bit messy and in the EPS I mean, you're talking a paint I mean, it's not a lot in the EPS.
This quarter and year to date, it's even less miles.
I think you can say, we probably had a penny just over from tax.
Corporate with lines, but what really encourages me and I think he is more important.
Or is as important as the gross margin that sort of factory manufacturing operational performance and we had great leverage over 50% and so that's what it tells me the business is moving in the right direction and we're hitting the margins we should be even caught me a little bit light in Q3.
Makes sense thanks Patrick.
Okay.
Your next question comes from the line of Pete Skibinski with Alembic Global Your line is open.
Hey, good morning, guys.
Just wanted to follow up to try to understand the seasonality aspect a little bit better I think I do right now I would think that even if there are fewer people working at Airbus in August that they would still be accepting and their supply chain will be accepting a lot of your product during the quarter in anticipation of the 2023 production.
Schedule. So so so what impacts that how does the seasonality impact you guys. Yeah. I mean, if you look at our history and perhaps we just need to sort of put the pandemic behind us a little bit, but I mean I looked back at the last decade, 2013, 14, 15 16, all the way back every Q3 steps.
And it's because of Europe , and as Lyne said, they do actually cut their production levels, they have vacation in Spain, and France, and it's been there forever.
And obviously, we lost that in the pandemic 2020 was well 2020 was this crazy 2021 was an exceptional sort of still growing out of that trough position I think what we're seeing in 2022 is a return to a more standard seasonal shape for hexcel in the aerospace industry in Europe , and that's what we saw in <unk>.
Combine that with a little bit of a strong dollar FX and you combine that with the throughput.
Nick alluded to.
And that's why you see this seasonal step down but I can tell you now every Q3, assuming things stay more or less normal going forward you will see this adjustment in our annual sales.
Okay. Okay fair enough last one for me is just.
As we think about the sequential decline in margin rate in the third quarter at both the segments.
Was that was that primarily due to lost volume lower volume and.
And how much from the.
We talked about the labor issues. There and then also I was wondering how much mix impacted as well.
Yeah, I mean, it wasn't overly significant I mean composite materials, obviously went down a little bit but it's on a.
Lower sales, so you're losing volume leverage I mean, I actually think we held our margins very well on water $30 million step down in total for the company quarter over quarter, and we've always talked to engineered products sort of being a mix because it programs common programs go but I would point you as I called out in.
Sort of the prepared comments that were 11, 5% versus 7% year to date and that just reflects our strengthening of sort of the average and quality of margins. We're seeing in that business. So I'm not overly concerned on those lowest styles and fits the leverage story volume leverage and as volume steps back up.
I am sure we will drive those volumes those margins again.
Okay. Thanks for the color.
Your next question comes from the line of Michael Chair, Mali with <unk> Securities. Your line is open.
Yes.
Hey, good morning, guys. Thanks for taking the questions I guess, just maybe maybe back to where Rob was asking on on costs and inflation and looking at raw materials. What are you guys able to offset with price.
As you guys think about your planning.
No Patrick you talked about the hedging, but how are you planning for these costs in 'twenty three and I guess, what are you seeing from your basic or from your recent hedging.
Yeah, I mean, Michael we start from and we've called it out many times, we have some really good mitigation.
With many major sort of purchase contracts are major resins and other key raw materials, we have long term purchase contracts, which go back to back with our commercial contracts and some of those go out to 2030. So that is a great initial protection and as I said I mean raw materials are our biggest cost elements.
The hedging as you just mentioned is around quick while we hedge propylene as a proxy for a credit of nine trial, which is a key raw material input for our carbon fiber is again smooths out cost.
So beyond that yet, we're not immune to inflationary pressures and through productivity and efficiency, we're having to sort of address and overcome that things like freight and utilities and minor raw materials.
And as we go forward into 2023, and we're planning we put in continuous improvement programs and operational excellence as we've talked to many times.
We take on that challenge to overcome those headwinds and to maximize margins as we can but we have a great foundation of some mitigation in long term contracts and hedging and then we operationally challenged ourselves to overcome remaining headwinds.
Got it and then just a follow up you talked about at one point you took out $150 million of cost has there been an update to what.
Amount of those savings do you think you can keep your especially I mean, just just thinking about the new hires and wages. How should we think about I guess layering on of those costs that you originally taken out and what can be short of sustaining savings.
Yes, I mean, we haven't specifically updated I think we've acknowledged that as volumes come back in the low point I guess, we were a $1 $3 billion company as we move to where we are today and towards $2 billion and beyond we will need to sort of add back some of that indirect costs back in well over half of it now we will try to hold on.
So as much as we can ultimately drive sort of better leverage and efficiencies.
Ultimately pushed our operating income margins to beyond where they were previously.
But so that's our goal we're going to maximize what we hold on to and that's what Nick and I are focused on as we move forward.
Got it thanks guys.
Your next question comes from the line of David Strauss with Barclays. Your line is open.
Okay.
Thanks, Good morning, everyone.
Good morning, David.
Wanted to ask about <unk>.
Even your your footprint manufacturing footprint in Europe , how do you feel about the the energy situation, there and any impact it could have on you.
Yes.
Well clearly we're watching it closely.
Probably the priority, we're keeping an eye on is Germany.
As you probably know we have one pre prep site in Germany.
From a risk mitigation and ability to deal with that is there.
Should be a rationing or.
Reduction in available energy in that region.
We have extra capacity on fleet.
We could reallocate that and move that and not disrupt our customer deliveries or our revenues so from that standpoint.
We think we're protected.
All that work too.
From a broader scale some of the chemical companies in the.
The German region.
The indirect impact could be bigger and we'll just monitor that.
Our team worked dual sourcing and making sure that our supply chain is adequately protected.
Okay.
Okay and then.
Patrick on on on currency just an.
An update on where you are from.
From a hedging standpoint and how.
How big of how big of a.
Positive benefit could it be as we look out over the next couple of years, just if we assume kind of euro dollar.
Parity from here.
Yes, I mean, I think we've called out year to date is about 30 basis points, obviously, the fourth quarter stays where we are today, that's probably going to nudge up slightly I don't know, but maybe 40 basis points for the year.
We've obviously been doing because of our 10 quarter Rolling hedging program is locking in the stronger rates.
As we look forward and we will see that impact in 'twenty, three and 'twenty four.
Especially as we go into 'twenty three again, our objective is to be roughly 75% hedged.
On a sort of sort of margin gap.
Currency exposure.
So there is an upside I mean, it's hard to call it out year over year as we lock in these I mean, what we're really doing with hedging a smoothing.
But yes, we've locked in some of this margin benefit for a period of time is the way I would summarize it.
But obviously the dramatic change we've seen in 'twenty to over 21, well I was about to say something dangerous. We don't expect to see that again, who knows I don't want to predict the future, but given how much hedging we've got locked in we feel in a good place with our FX going forward.
Could you say what your average hedge rate is and then in 2022.
I don't know, we've never really disclose that I mean, if you look back over the last sort of two or three years and average it out we're going to be close to that I think that's all I'll say.
Thanks.
Your next question comes from the line of Kristine <unk> with warm stack.
Stanley Your line is open.
Hey, guys.
When you look at working capital headwinds this year despite that.
Our business is still generating positive free cash flow and you've talked about how you expect excess inventory unwind through 2023, and when you think about 2023 should be a higher free cash flow year than 2022 at the very least.
How are you thinking about capital deployment and priorities for that between allocating capital for incremental M&A or return to shareholders.
Yeah, Hi, Christine.
I mean going forward as we've been signaling for some time, we are looking towards strong cash generation for a number of years.
Our capital expenditure will remain subdued.
And we're going to generate significant free cash flow and therefore to your point, we will be looking at sort of capital allocation. We are already paying a dividend. Our board of directors will continue to review that on a quarterly basis and the level and we will do that as we go into 2023.
And then yes stock buyback comes back on the table along with M&A now in a disciplined way, we will always look at M&A opportunities and if we can repeat something like technologies would be excited to do that.
But until then we will look at share buyback I mean, I think it's too.
I don't have anything specific to signal today, but with the cash we will have in 2023 and beyond that will definitely be on the agenda, yes.
Thanks, Patrick.
Your next question comes from the line of Gautam Khanna with Cowen Your line is open.
Hey, Good morning, guys, Hey morning, good morning Gautam.
A.
Question on a follow up just first on Q4 guidance in the range I'm, just curious sort of what are the puts and takes that could swing it to the lower high end.
And then as a follow up just on the 787 could you remind us kind of how concentrated your customers are there is it pretty dispersed like it is on the <unk> hundred 50 across multiple contract manufacturers or is it.
Kind of spirit.
Largely in one or two thank.
Thank you.
Okay.
With respect to the guidance.
Our midpoint gives you really the fourth quarter guidance and Thats what.
I would recommend us what what could impact that.
Well clearly our rate on training efficiency and throughput.
Catching up some of that delivery in Q3 that we've talked about that we couldnt get out of the shop that certainly could help push us above the mid point.
I really don't see a program scaling down so.
Not to say that something couldn't happen, but it seems less likely that the <unk>.
On slide would be at risk.
With respect to your question on the <unk> hundred 50, there really is not.
One.
Many customers I think we have 40 to 50 different ship to spoke of 350.
Probably one of the biggest ones is Airbus.
You look at all the sites we ship into.
Spirit or.
Some of the other tier ones tier twos.
It's spread.
Pretty widely across that supply chain.
I meant on the 87 I apologize by analogy is it is it similar to the <unk> hundred 50 in terms of it being distributed or is that largely to one or two.
I'm trying to gauge kind of what levels of inventory channel and if you have a view.
The H southern certainly has fewer.
And different mix of the products, but theres not a specific tier one that stands out that I would highlight that drives the majority.
Thank you obviously, we've got an excellent engine and nacelle content so that.
As one of the big drivers on the supply chain pulse.
Thank you.
Thank you.
Your next question comes from the line of Sheila <unk> with Jefferies. Your line is open.
Thanks, so much.
Nick and Patrick.
I wanted to follow up on the last question about margins you know when we think about the implied Q4 margin of nine 5% versus the.
I couldn't ask for centers that you've done year to date.
What's wrong with down 100 bps quarter over or in.
In the fourth quarter and is that sort of the run rate base, we should be working off for 2023.
So obviously, what I can say is we don't guide to a quarter, you've obviously backed into that from the annual numbers, which is a range.
Our target is very much to drive double digit operating income margin for 2022, I think that's what we talk to as we came into the year and it is still our objective today.
I understand how mechanically you backed into that number but.
But we're going to push margins and EPS in the fourth quarter as strongly as we can and we are definitely aiming for double digit operating margins.
As we go forward.
Okay, and then just on defense, if we could talk about that.
Again this quarter after being up low single digits in the first half.
How do you kind of expect that to trend has it changed at all and how is that 35 sort of impacting that.
F 35 is a little bit lumpy.
I mean, we've had Lockheed talk about sort of some supply chain challenges I am personally I wouldn't overplay. It I don't think now we're going to get to that sort of top raised 156 next year, but I think we're not going to be far off there and we still see it as a very positive and significant program from us.
And with the CH 53, K growing strongly and military budgets generally improving we see space and defense continuing to be a solid sort of market for us.
Okay, great. Thank you.
Your final question comes from the line of.
Richard Safran with Seaport Research partners. Your line is open.
Nick Patrick Kirk good morning.
Good morning, Richard.
So firstly.
Could you discuss a bit more about share gain opportunities for your end markets.
I think this is probably for you, but I think you already mentioned defense is the right way to think about share gains for <unk> cel was that commercials, mostly spoken for share gains are mostly going to be in defense and maybe industrial so as you look forward.
Well, we know the qualification and the sole source positions.
Many of our markets so.
On commercial aerospace again, there are small opportunities here and there that's really positioning for the next new engine nacelle, Wayne or new entire aircraft space and defense there are opportunities there as new programs as well.
Well as things like the CH 53, K ramp that we announced which was a nice win.
Nice.
Myology and high growth area for our campsite or engineered products and again when we were in the process of transitioning all the Boeing.
More commoditized type work to our joint venture in Malaysia. So that was always the strategy was backfill that with higher margin higher technical requirement type products and solutions.
Again space and defense there are opportunities we continue to pursue those.
Clearly our focus is on new platforms, Florida power, we've got great positions with both.
All key competitors in that work.
Actually agnostic we're excited.
Clearly those platforms will have significantly more volume than the platforms I felt replaced.
<unk>.
Not volume ship set content.
So we're excited and then industrial industrial is.
We're very selective.
And the areas looking for lightweight durable composite pipe materials, just continues to expand transportation, we mentioned marine that's been growing nicely for us.
Very selective in certain electronic applications recreation remains strong so there's a whole host of sub segments in the industrial that our teams continue to monitor.
And we are selectively growing there in positioning our technology for long term sustainable growth and profitability.
Okay.
Just real quick Patrick with respect to your comments about debt levels and pay down I'm. Just wondering if youre now thinking that you're pretty close to an optimal capital structure. If there and are there any other balance sheet improvements you think you need to make tended to think based on your remarks no.
No I mean, we can tell you we're going to generate cash.
Have some fixed bonds about $700 million as you know we will be using very little of our revolver as we move through next year. So it's going to give us a great platform for capital allocation as we start to evaluate them.
Okay. Thanks, very much for the color gentlemen.
Yeah.
Ladies and gentlemen, thank you for participating. This concludes today's conference call you may now disconnect.
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