HXL - NYSE

Good morning, ladies and gentlemen, and welcome to the Hexcel Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode, and please be advised that this call is being recorded. After the speaker's prepared remarks, there will be a question-and-answer session. [Operator Instructions] And at this time, I would like to turn the call over to Mr. Patrick Mitelich, Chief Financial Officer. Please go ahead, sir.

Thank you, Dan. Good morning, everyone. Welcome to Hexcel Corporation's second quarter 2023 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. Certain statements contained in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the company's SEC filings and 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. Your participation on this call constitutes your consent to that request. With me today are Nick Stanage, our Chairman, CEO and President; and Kurt Goddard, our Vice President of Investor Relations. The purpose of the call is to review our second quarter 2023 results detailed in our news release issued yesterday. Now let me turn the call over to Nick.

Thanks, Patrick. Good morning, everyone, and thank you for joining us today as we share our second quarter 2023 results. We started the year with great momentum that is carried forward into the second quarter as we delivered a solid year-over-year increase in sales of almost 16%, reflecting robust demand for lightweight advanced composites and strong execution. We continue to manage and mitigate supply chain constraints, inflationary pressures and a tight labor market to protect our customers' requires. As we work through these issues and global supply chains continue to improve our confidence increases. While delays and cancellations at airports this summer have been frustrating for many, it reflects an industry with high demand and growth. On June 30, TSA screened almost 2.9 million travelers, marking the highest daily number of passengers the agency has screened on record. According to the International Air Transport Association, domestic travel in key markets globally is now on average 5.3% higher than 2019 levels. International travel is more than 90% recovered and May 2023 was the first month that the global passenger load factor had returned to 2019 levels. Looking back to the depth of the pandemic. There were many who doubted that air passenger traffic would recover to these levels by mid-2023. Growing passenger demand, both domestically and internationally is great news for our customers and for us. Commercial aircraft order backlog now at a combined level of over 13,500 aircraft for Airbus and Boeing are just above the prior peak levels. Demand is strong for next-generation fuel-efficient aircraft with lower emissions and improved long-term maintenance costs. The demand for advanced composites and secular penetration opportunities continue to grow, and Hexcel is well positioned to keep winning in this space with our broad portfolio of lightweight solutions. Now let me highlight some of the results of the second quarter, and Patrick will then provide more detail on the numbers. Commercial Aerospace sales of $264 million increased more than 15% in constant currency compared to the second quarter of 2022. The strongest growth came from the Airbus A350 and Boeing 787 wide-body programs. Other commercial aerospace increased more than 13% for the second quarter and continued robust business jet demand. Announced orders and options for narrowbodies, including the Airbus A320neo family, the Airbus A220 and the Boeing 737 MAX remained strong in the second quarter, including growth in new regions and re-fleeting in existing markets to improve fuel efficiency and reduce operating costs. We remain agile and aligned with our customers and ready to support their growing demand. In response to some of that increased demand, we celebrated the expansion at our facility in Casablanca, Morocco in May. The plant, which first began production in 2018 has now doubled in size as we ramp up to meet the growing requirements for lightweight composite engineered core materials in the region. I also want to mention that earlier this month, we received or we learned that for the fourth consecutive year, our team at Casa Grande, Arizona has been recognized by Boeing with the Supply Chain Performance Achievement Award for superior supplier excellence. Hexcel is the world's largest honeycomb provider for the aerospace industry produced at our Casa Grande, Arizona and Duxford U.K. plants. Turning to Space & Defense. Sales of $138 million increased 22% in constant currency with broad-based growth across a number of platforms globally, including fighter aircraft, such as the F-35 and Rafale, as well as space programs and civilian rotorcraft. This level of quarterly sales for Space & Defense is our highest ever. Our Space & Defense business is supported by our team in Amesbury, Massachusetts where we produce materials for multiple U.S. defense programs, including the F-35. You will recall that we acquired this business in January 2019. This has been an excellent strategic acquisition for us. Amesbury is a high-quality business that broadens our product line and enables innovation and deeper conversations with existing and potential customers regarding our composite solutions. Since the acquisition, Hexcel has leased the building from the former Art Technologies owner. But we - when we recently had the opportunity to buy the property, we glad we did so and closed the deal around the end of May. Ownership provides Hexcel with control and flexibility of the site, which will simplify our ability to grow and expand operations to meet the many opportunities we foresee in the years ahead. This step to acquire the site is a clear signal that the Amesbury team is now fully integrated into our one Hexcel family. Total Industrial sales of $53 million decreased about 3% in constant currency due to lower wind energy sales that were only partially offset growth in automotive, marine and other industrial markets. Year-to-date, total Hexcel sales of $912 million are up more than 16% year-over-year in constant currency and EPS is up 82% from $0.55 this time last year to $1 at the end of June 2023, all of which reflects Hexcel's strong performance and growing momentum. Before I hand over to Patrick, I'd like to say we were excited to return to the parasocial [ph] last month. As always, it is thrilling to see all the aircraft on display, knowing that Hexcel has extensive and growing product content on practically every aircraft flying and in development today. We have many face-to-face customer meetings to talk about how our lightweight solutions will propel their next-generation products, which always is the best part of the event. And it was made even more notable this year as we hosted about 180 customers for a special event to celebrate Hexcel's 75th anniversary. At the show, we launched two new aerospace products that each deliver faster cure cycles, enabling higher production throughput rates. We also exhibited parts made with our advanced composite materials by Airbus for the Wing of Tomorrow project. We congratulate Airbus on the recently announced opening of a new wing technology development center in Chilton, U.K. and look forward to our continued collaboration on making longer, thinner and lighter aircraft wings, which represent one of the biggest opportunities to improve fuel efficiency, reduce CO2 and ultimately work toward the air transport industry's carbon emissions reduction goal. Finally, our Hexcel leadership team had the opportunity to ring the opening bell at the New York Stock Exchange in June in recognition of Hexcel’s 75th anniversary. The last time Hexcel had the privilege of ringing the bell was in 2005 when we celebrated 25 years on the stock exchange. This was truly an experience for all of us and a great way to represent and recognize our one Hexcel team for their hard work and effort that has led us to this anniversary year and a significant moment in our history. Now I'll turn it over to Patrick to provide more details on the numbers.

Thank you, Nick. 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 strengthens 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 hedge this currency exposure over a 10-quarter horizon to protect our operating income. As a result of currency changes are layered into financial results over time. As a reminder, the year-over-year sales comparisons I will provide are in constant currency, which thereby removes the foreign exchange impact to sales. Turning to our three markets. Commercial Aerospace represented approximately 58% of total second quarter 2023 sales. Second quarter Commercial Aerospace sales of $264.3 million increased 15.4% compared to the second quarter of 2022, led by growth in the Airbus A350 and Boeing 787 programs. The other Commercial Aerospace category grew 13.3% led by strength in business jets on greater adoption of lightweight composites in the latest generation of large cabin business jets. Space & Defense represented 30% of second quarter sales and totaled $137.5 million, increasing 22.1% from the same period in 2022. Fighter Aircraft were particularly strong, including the F-35 and Rafale and Black Hawk and civilian rotorcraft also grew strongly, along with a solid performance for space. Industrial comprised 12% from second quarter 2023 sales. Industrial sales totaled $52.5 million, decreasing 3.3% compared to the second quarter of 2022 as growth in other - in automotive and other industrial markets did not offset the lower wind energy sales. On a consolidated basis, gross margin for the second quarter was 24.4% compared to 22.8% last year. The gross margin this quarter was consistent with our expectations, following an unusually strong first quarter 2023 gross margin due to a number of factors we called out on our last earnings call, including favorable sales mix with strong demand for Hexcel fiber-rich products and significant overhead absorption from increasing inventory. As a percentage of sales, selling, general and administrative expenses and R&D expenses were 10.8% in the second quarter compared to 11.4% in the second quarter of 2022, reflecting robust cost control as sales grow. Adjusted operating income in the second quarter was $61.8 million or 13.6% of sales compared to $44.7 million or 11.4% of sales in the comparable prior year period. The year-over-year impact of exchange rates in the second quarter to adjusted operating income was favorable by approximately 30 basis points. Now turning to our two segments. The Composite Materials segment represented 83% of total sales and generated an operating margin of 16.2%. The operating margin in the comparable prior year period was 14%. The Engineered Product segment, which is comprised of our structures and engineered core businesses, represented 17% of total sales and generated an 8.9% operating margin as compared to 12% in the comparable prior year period. The operating margin was softer than normal in this quarter on sales mix and higher development and tooling costs related to the [indiscernible] and various space programs. The effective tax rate for the second quarter of 2023 was 22.1%. Net cash provided by operating activities is $30.1 million year-to-date compared to $18.3 million in the first half of 2022. Working capital was a use of cash of $113.9 million year-to-date to support higher sales. For the comparable prior year period, working capital increased $95.1 million. Capital expenditures on an accrual basis were $70.5 million in the first half of 2023, which includes $37.8 million for the Amesbury, Massachusetts property purposes discussed by Nick. This compares to $28.3 million in the prior year period. I would also like to mention that early in July, we sold our former wind energy facility in Colorado for $11 million. This was an asset that was held for sale and will be accounted for in the third quarter of 2023. Free cash flow for the first 6 months of 2023 was negative $44.7 million, which includes the Massachusetts property acquisition for the comparable prior year period, free cash flow was negative $19.6 million. For an alternative metric of cash generation, adjusted EBITDA in the second quarter of 2023 was $95.6 million or 21% of sales compared to $78.8 million or 20% of sales in the second quarter of 2022. As disclosed on our last earnings call, we renewed and extended the maturity date for our bank syndicated $750 million revolver. The leverage liquidity covenant calculation is now on a net debt basis, as a result, we may trend a little lower in our desired leverage range of 1.5 to 2 times, as we have previously defined that range on a gross debt basis. The Board of Directors declared a $0.125 quarterly dividend yesterday, payable to stockholders of record as of August 4, with a payment date of August 11. We did not repurchase any common stock during the second quarter of 2023. The remaining authorization under the share purchase program at June 30, 2023, was $217 million. As you read in our release last night, we are updating our 2023 guidance. We have raised and narrowed our sales guidance range to $1.765 billion to $1.835 billion. And similarly, we have raised and narrowed our EPS guidance range to $1.80 to $1.94. Our guidance for free cash flow is updated to reflect the purchase of the Amesbury, Massachusetts property. Free cash flow guidance is now to generate more than $110 million with accrued capital expenditures in 2023 revised to approximately $130 million. And as a reminder, on sales forecasting seasonality, we typically experienced softer sales in the third quarter of the year due to some applications, particularly in Europe. With that, let me turn the call back to Nick.

Thanks, Patrick. We are confident that the outlook for Hexcel continues to get stronger with expectations for significant cash generation in the coming years. As we plan for that cash generation, our capital deployment priorities remain unchanged. First, we will invest in organic growth opportunities to support secular penetration and expanded composite adoption. Both for the next few years, we expect our capital expenditure requirements to be subdued as we grow back into and optimize our existing capacity and footprint. The next priority is to explore in a disciplined manner, high-quality M&A opportunities involving innovative and value-adding material science technology. We'll continue to pay a dividend. And depending on these activities, we will repurchase our stock while staying aligned with our target leverage range. Before we take questions, I want to note that last week, our global team were in Stanford for our annual strategic review, which is three days of sharing and collaborating on the new and expanded business opportunities that lie ahead for our markets, our customers and Hexcel over the next 5 to 10 years. While we packed a lot into that meeting, at least two things were crystal clear. First, our advanced composite materials are a key enabler in helping our customers meet their efficiency and sustainability targets. And that value proposition continues to expand as the focus on global emissions reduction increases. We look forward to continuing our relentless pursuit of new technologies and lightweight material solutions that enable our customers to achieve their goals to optimize fuel consumption, lower emissions, reduce noise and help sustain the planet for generations to come. Second, we are absolutely ready to meet the growing demand forecasted over the coming quarters and years. All that we did during the pandemic to become lean and efficient and all that we have done since to prepare ourselves for robust growth is paying off. We are aligned with our customers. We are adept at pivoting and flexing with changing requirements, and we have demonstrated time and again that we know how to work through uncertainties or challenges that arise. Our one Hexcel team will stay focused on efficiency and productivity, cash management and overall performance, especially in quality and on-time delivery. I remain extremely confident in Hexcel's future and our ability to continue delivering value to our stockholders. Thank you. Paul, we're now ready to take questions.

Thank you, Mr. Stanage. [Operator Instructions] We'll go first this morning to Ken Herbert at RBC Capital Markets.

Yeah, hi. Good morning, Nick and Patrick.

Good morning, Ken.

Morning.

Yeah. Just first, I wanted to just clarify on the free cash flow outlook. I think, obviously, the facility acquisition justified the majority of the change in the cash flow outlook. But can you comment on any other moving pieces that we may or otherwise would have expected to see in the cash flow guide?

Yes. So I mean, and it really was driven fundamentally by that onetime in July, slightly exceptional capital expenditure to buy the property that essentially moves us down really from 140 to 100. But we felt a little bit more confident with the earnings that we see coming through and the outlook and getting control of inventory now for the rest of the year that we posted to 110. So there's not a lot more to it than that. So really recognizing the Amesbury property purchase and some underlying strength.

Great. Thanks, Patrick. And as I look at the full year commercial aerospace growth, you obviously saw some slightly slower growth in the second quarter. I think the guidance would imply sort of high teens for the full year. Is the growth rate for Aerospace in the second quarter, a fair starting point as we think about the second half of the year? Or does it maybe soften a little bit from where you are today?

Well, I mean we've called down the seasonality with Q3 and particularly the European vacations. And so that will slow things down a little. I think the question really is how strong is the fourth quarter going to be. Everyone has obviously read about the raise in Pratt & Whitney [ph] engine issue this morning. There were always challenges out there. But fundamentally, we're confident the underlying demand is fantastic. Our content on all these platforms is strong. And we're obviously willing Airbus and Boeing to move forward as strong as possible. So we're still pretty positive, but we recognize it's not always going to be a smooth path, but it should be a solid second half of the year, especially the fourth quarter.

Okay. Thanks, Patrick.

Thank you. We go next to now to Gautam Khanna at Cowen.

Hey. Good morning, guys.

Morning.

Morning, Gautam.

I wanted to just ask, in the quarter itself, did you guys see a rate increase on 737 MAX, A220 [ph] You cited a couple of programs on 350 and 787 year-over-year, but I didn't know sequentially, you saw much change across any of the programs?

Yes. So if you look at the first half, we're clearly aligned with Boeing in the low 30s on the range. There's a little bit of movement between first and second quarter, maybe some supply chain restocking happened in Q1. So we saw a minimal decrease sequentially, Gautam.

Okay. And just stepping back, do you feel like most of the supply chain, most of your customers are aligned on rate across the board? I mean, with underlying assembly rates at Boeing and Airbus? Or is there anyone that's out of whack noticeably?

Well, we pay a lot of attention to the supply chain and especially looking for outliers that may be pulling excess material or not pulling enough. And right now, we see our supply chain throughout the OEs and the Tier 1s, 2s and beyond to be pretty much aligned on the product lines that we're providing.

Thanks a lot, guys.

Thank you.

We'll go next now to David Strauss at Barclays.

Thank you. Good morning.

Morning.

Just want to - first question on margins in the quarter. So could you just maybe touch on the mix, all the different things that might have impacted the margin in Composite Materials in Q2 versus Q1? I mean, the revenue was fairly similar. The margin, obviously, was down a decent amount. So if you could address that first?

Yes. I mean I think that we tried to call out in Q1, and I think I've just touched on in the previous comments. Q1 really was - as things aligned, it was somewhat exceptional. We had a very strong product mix, if you like, Hexcel carbon fiber rich product mix, and that always drives our strongest profile of margins. And so we had a good weighting of that in Q1. We also had quite a lot of inventory build in Q1. And that, combined with good cost control, led to very good overhead absorption. And so with that strong mix of Hexcel fiber products, good sales, leveraging over a controlled overhead base and combined with some inventory build. That is really – that is really the key factors that drove that strong or very strong Q1. I would say Q2 is back more in the normal solid range. We would expect to be performing with this level of revenue is the way I would frame it.

Okay. And I guess a question on where we go from here. I think previously, Patrick, you talked about mid-teens margins, total margins for the company on $1.8 billion to $1.9 billion of revenue, you're going to be kind of at the bottom end of that range this year. It doesn't look like based on your EPS guidance that you're implying that you're going to get all the way to mid-teens margins. So how do we think about the margin progression from here as volumes continue to go higher? Thanks.

Yes. I think we talked to this probably in the fourth quarter and then after the Q4 earnings. Essentially, the inflationary pressures last year probably pushed us back a bit on that mid-teens $1.8 billion to $1.9 billion sort of model. And I think we acknowledge we would be at the low end of that range and it would now be a struggle to get to something like 15% with 1.8%. I think a lot of the inflationary pressures are transitory. So energy costs are going to anticipate certainly as we look forward into 2024, some of the commodity chemicals and raw materials that we buy are going to knees off. And so the general shape of what we put out there is fundamentally correct, but we have been delayed in getting there. So as we now approach 2024 and our sales are going to step up again significantly, we will definitely be looking at that mid-teens and maybe slightly higher range for our operating income. And then as we go above $2 billion and continue to drive up to back to where we were in 2019, we should be pushing ourselves back to the 17%, 18% of income that we historically saw and ultimately, we'll be looking to push part that.

Thanks very much.

We'll go next now to Robert Spingarn at Melius Research.

Hey, good morning.

Good morning, Rob.

Nick, I think you just said or maybe Patrick said it, but you're pretty aligned with Boeing on the map in the low 30s during the second quarter. When would you expect to start building to that 38 per month? And then I have another quick one on future programs.

Yes. I basically confirm that we are very aligned with Boeing, not only on the back, but on the 787 running at about 4 and low 30s on the MAX. We have the capacity. We are ready to ramp up, and we're not going to get ahead of Boeing. But as soon as they start pulling material at a higher rate, getting up to their 38 target or 41 or even 50 and 25, 26, we're going to be aligned with them. So to put a prediction on that, I'll let Boeing talk to that tomorrow.

Okay. And then a couple of things on Airbus. There's been some talk that the 321 XLR may be hitting some weight challenges that might affect range. To what extent are you talking to them about maybe increasing your lightweight material content to mitigate that? And then you also talked about having brought in your team on future programs, so that must be fresh in your mind. And you mentioned the Wing of Tomorrow facility in the U.K., and I wondered if you could speak a little bit to the Hexcel opportunity on Wing of Tomorrow?

Yes, Rob. So to start with on the XLR, we're seeing what everybody else is seeing and reading on some weight challenges related to the central fuel tank in the back of the aircraft and some additional waning [ph] lighting that's going to take place. I can tell you, we're intimately involved with Airbus on their development efforts. I can’t call out this specifically because it's related to a fuel liner, and I don't want to get into the details. But anything that they can do to decrease that weight impact. They certainly know our portfolio. They know our capability, and they know the areas that we can continue to help them to drive weight out. So that's ongoing. Again, I'll let Airbus talk to that point tomorrow during their earnings call. On the Wing of Tomorrow, it's exciting, obviously. It's - there really is no final Wing of Tomorrow as of yet, there's a lot of demonstrations. There's a lot of different material product forms and what I'm so excited about with Hexcel is our portfolio allows us to position multiple material types to help optimize that wing. And it depends on the type of ultimate technology that's selected. So we believe we're in a great position. We believe that Airbus have a fantastic path forward to continue to decrease weight, increase strength and optimize the future wings for the next new narrowbody or any other derivatives they move forward with.

And Nick, do you think that they've got the technology where it needs to be, and I'm speaking specifically to composite wing, where it could keep up with the types of rates that are necessary in narrowbody?

I think they have the technology and they could launch a win today, absolutely. I think they are still evaluating that technology and the rate throughput, not only in the material laydown rate but the material cure rate and the downstream processing, all of that is being evaluated with the various material forms. And I can just say I'm excited that we're side-by-side with them, helping them to optimize that design.

Great. Thanks, Nick.

You're welcome, Rob.

Thank you. We'll go next now to Matt Akers at Wells Fargo.

Hey. Good morning, guys. Thanks for the question. Maybe to put a finer point. Could you talk about the decision to buy the Amesbury facility? What drove that? Was it just that the prior owner was looking to sell and you want to be the owner? It seems like it wasn't in the original plan for the year.

So you're right. It was not in our original plan for the year, and that's one of the major reasons or the major reason why we updated our guidance on cash and CapEx. When we acquired Amesbury, our technologies, we were excited to find that technology that so cohesively fit into our existing portfolio and technologies and how to add value to composites. As you know, it's primarily a U.S. military product site, but the opportunities around what they do and how we can enhance our overall composite offering that's tremendous. And our excitement just continues to grow with that site. When Dan Healy, the prior owner approached us and we found out that he was going to market that property. He wanted to change direction. We took the opportunity to pursue it so that we could control the expansions there. We could control the facility modifications and consolidations and really continue to drive the growth and the efficiency that we see in the coming periods.

Got it. Thanks. That makes sense. And then if I could ask on industrial. I know the wind compares get a lot easier in the back half. But can you just talk about sort of how you think about that business growing sequentially after kind of step up sequentially we saw in Q2?

Well, I think we've said before, wind has pretty much stabilized for us in the second half of ’22. Obviously, that's driven by Europe, by the legacy products that we're supporting there. And we do see it stabilizing and continuing to be a solid business for the foreseeable future. Clearly, automotive, marine, other industrial continues to grow nicely, and we see that offsetting or basically driving some of the significant growth we see in the go-forward period on the industrial side. Recreation has been a little softer on some winter sports and some of the wet goods. But again, that tends to be a little bit impacted by GDP and inflationary pressures. And again, the product offerings we have there and the technology we're introducing there, we continue to see that as being an opportunity going forward.

Great. Thank you.

Thank you.

We'll go next now to Sheila Kahyaoglu at Jefferies.

Thank you. Just wanted to ask on Base & Defense, good growth in the quarter. What sort of drove that? And as you think about 2024, are there any platforms that decline upon B ‘22 [ph] in defense?

So really, what drove it the F-35 was very strong for us in Q2. The Rafale was very strong. We saw civil helicopter step up nicely. Black Hawk was up strong, and we saw space applications, which is U.S. driven, although we've got good positions in India, which stepped up nicely. So all in all, it was very broad-based, but those were the primary drivers. In 2024, there's really nothing new. I'd say the CH-53K, there's a lot of optimism around that, continued growth in the F-35 as Lockheed ultimately will hit their targeted delivery and build rates. And perhaps some softness in the B-22 [ph] but people have been talking about that going down for a long time, and it just continues to hold strong. So I'll wait until we roll up our '24 plan before I really guide more on what's going to be the puts and the takes in the Space and Defense side.

Sure. Thank you, Nick. And then, Patrick, if I could ask one for you. No, I understand you don't want to deal with a new landlord. So you purchased that facility from ARC. How do we think about your other capital allocation and when you start buying back shares? What's your sort of metric and analysis you do behind resuming your share repurchases?

Yes. So we continue - I mean Nick laid out our capital deployment priorities, which haven't changed the organic growth, disciplined M&A, will pay dividends. And so share buyback kind of becomes the default sort of last stock, which we will do. We're not going to sit on mountain [ph] amounts and piles of cash. So as we go through the rest of this year and we will start to generate some cash now in the second half, which is the typical profile for Hexcel and certainly going into '24 and beyond. We will expect to engage in share buyback, not going to call out specifically what and when at this point, but it's very much on our agenda in the coming periods.

Thank you so much.

Thank you. We'll go next now to Pete Skibitski at Alembic Global.

Patrick, maybe just extending your comments in the third quarter revenue-wise. Margin-wise, should we expect third quarter margins to be down sequentially? Or do you have a sense already about the carbon fiber picks in 3Q versus 2Q that could maybe offset it?

Yes. I mean what I would say in terms of fiber mix is that Q1 was unusually strong, perhaps going forward for the rest of the year, we'll see a more normal profile as we saw in the second quarter. I mean, in terms of margin, and we don't - I'm not going to get into sort of quarter-by-quarter predictions or come up with any specifics, but a lower revenue that we are expecting because of the seasonality will give us less or lower sort of overhead volume leverage, if you like, which makes that bottom line a bit tougher. But it's a top line issue. It's not a margin quality issue going forward. And then if the revenue steps back up in the fourth quarter, we should be driving back to strong margins again.

Okay. Thank you.

We’ll go next now to Richard Safran at Seaport Research Partners.

Nick, Patrick, good morning. How are you?

Good morning, Richard.

Nick, since you bought it, I'd like to ask you about the materials that you were highlighting in Paris and highlighted or enabled the higher build rates. So I just want to know if you could discuss what platforms they might be being targeted for commercial, defense, both. And generally, when you have new aerospace materials, they have a long-term payout. And I'm wondering if that's the case here? Or might there be more of a near-term payoff for these materials you've been talking about?

Yes. So again, there's multiple versions, and we're talking about the laydown type, whether it's a pre-preg, whether it's an abused [ph] product form, whether it's cured in autoplays [ph] under pressure or out of autoplay, we're working all those technologies, and they're on the table, some more mature than others. With respect to the Boeing and Airbus and again, you look at the material cost as being one element, but the laydown in the processing and the curing and the after machining is also something that we work with our customers diligently on. I would say the new materials, for the most part, run on our existing assets. So with respect to our flexibility and our plans, it makes for a very easy transition. It's just a question of qualification for the application.

Okay. Thanks. And then, Patrick, just a quick one. You've been talking about back half and margins. And if you've answered this and I missed it, I apologize, but I want to know about working capital in the back half of the year, specifically, I guess, inventory. Given the expected 3Q seasonal slowing, is it correct to assume that most of your working capital benefit shows up in the fourth quarter. Is that the way it should trend this year?

We should definitely see a working capital benefit in the second half of the year, I would expect, driven by inventory. I think we kind of turned the corner in the second quarter inventory was essentially flat. It was a few million dollars up. But essentially, we saw the growth that we've seen in the sort of the second half of 2022 and the first quarter of '23. So I would expect that trend to continue and our inventory, in fact, reduce. And so that should drive some working capital reduction and therefore, cash positive cash flow. Receivables will reflect the level of sales. And so we seasonality and lower Q3 sales receivable will probably step down, but then they're likely to come back again in the fourth quarter. But overall, driven by inventory, I would expect a positive cash flow impact from working capital in the second half of the year.

Well, thank you very much.

We’ll go next now to Kristine Liwag [ph] at Morgan Stanley.

Great. Patrick, on the Airbus A220-500? Or should I say the potential Airbus A220-500. Can you provide any color in terms of the maximum ship set content you could potentially win? Is there an opportunity for Hexcel IM fiber for the aircraft? And should you get the upper end of your expected shipset content? How do we think about CapEx requirements to meet that program?

Okay. So there was a lot of questions in there. So essentially, the 220 today is we call out in sort of $200,000 to $500,000 range in terms of shipset is probably at the lower end of that range. I mean, if we were to win a significant position, the wing on the 220-500 and we'll be aiming for other opportunities as well if they reengineer that platform. But clearly, we see a significant step-up in the shipset. I mean, multiple times what we have today, not going to try and give a number, it's far too variable, but clearly, it's a great opportunity. Would it attract IM fiber, but very likely to attract IM fiber of some sort. If there's a wing involved and you need the structural integrity that the IM fiber bring. So again, Hexcel fiber-rich opportunity would be great. In terms of capital expenditure, I wouldn't put it too much. We are bringing on, as you know, we're completing a new fiber line and we have a pan line in the works in the case of Alabama, which we put on hold as we went into the pandemic. And I would imagine that capacity, certainly in the next few years, we'll cover it. Now if the platform grew significantly, combined with other opportunities, we will gladly invest in capital for strong, long-term returns and good margins.

Great. Thank you for the color.

We’ll go next now to Myles Walton at Wolfe Research.

Thanks. Maybe to follow up on that, Patrick, or how much of the sales today with think of materials is supplied or furnished with your own fiber or vertical...

Well, I'll turn that around a little bit. I don't know that we're explicit on that, but we use 70% to 80% of our own fiber. So the fiber we produce, we consume the vast majority internally. Now we're not at the full capacity we were in 2019 yet, but it is stepping up, and we are using 70% to 80% of what we produce. The remainder goes to third parties, military outlets and a smaller amount goes to industrial. But we use the vast majority of our own fiber.

And you procure from external sources, less fiber in there - what you're producing internal?

That is true for some of the older legacy programs is really where we're buying in third-party fibers, and that will continue because those programs are long term qualified and very unlikely to be requalified. And so yes, we do buy in third-party fiber, but it is a smaller quantity than we use of our own fiber.

Okay. Fair enough. And then looking to cash flow, is there a path to 100% net income to free cash flow conversion in '24? Or is the growth...

I think the simple answer is yes. We're definitely driving towards that whether we'll get there in '24, I don't know, but we're definitely moving in that direction in the next year or 2 miles, yeah.

Okay. Perfect. That’s only my two. Thank you.

We'll go next now to Ron Epstein at Bank of America.

Hey, good morning. Maybe a quick financial question and then maybe a more technical question. The finance one first. I mean what are you guys seeing out there in the M&A environment? Is there any interesting add-on things that you want to do technologies or whatever? I mean if you could just share a couple of words on that. And then I just have a quick technology question.

Yes, Ron. So as part of our strat review, obviously, M&A and more importantly, technologies around material science is a big portion of our review process. And I would say there are technologies out there that are attractive, that would enhance our portfolio, allow us to offer broader solution set to our customers, whether that's a value add to the materials or something capability to do on condition maintenance or diagnostics. To get into the specifics on companies, obviously, is tough to do. And as always, it always comes down to what's actionable. So we have a pipeline that's very active. We review it on a regular basis. We have our priorities that our pipeline is based on, and we continue to work those and stay mindful, but always disciplined on what we would consider going forward.

Got it. Got it. And then on the technology side, when we think about future wins, and that's come up a couple of times here in the context of an A22500 [ph] or a future win. Would you expect it to be kind of how they're doing it today with the tape lay up? Or would you expect it how, I guess, how the 220 does it within an injection molded technology or something completely different? I mean how are you thinking about that when we think about the future application of advanced composites on something like a wing? I mean just can you give us a broad context for that.

Yes. So that's a great question. And it's one of the focuses on Hexcel's strategy, and that is we're not making the assumption that a wing will be designed with one material type. The technology has advanced so rapidly, our customers' knowledge and ability to design and work with multiple material forms, all composite lightweight just allows them a great opportunity to optimize the wing. So when you're talking about a wing skin versus a wind strike versus [indiscernible] versus brackets, really what I believe and what Hexcel's position for is it's not going to be one material type. It could be a combination of thermal set, thermal plastic, prepreg infuse and liquid compound molding. And again, that's the beauty of our diverse portfolio.

Got it. Thank you.

You're welcome.

And go next now to Michael Ciarmoli at Truist Securities.

Hey. Good morning, guys. Thanks for taking the question. Just on - back to – how are you? Just back to CapEx on the facility purchase. I mean you kind of said in the past 100% conversion is still there. Does anything change in terms of your CapEx profile to support the new facility? Or how should we think about your CapEx spend there?

Our CapEx outlook remains unchanged, really. As I think I described there, I would see this property acquisition is a little bit of an exception to our underlying trend and our underlying trend is to sort of be under $100 million subs for the next few years. We guided to around 90 this year. And I would ee a similar shape in the next few years. This building, so to speak, with an outlier, the opportunity arose and as Nick described strategically and for the growth opportunities, we want to be in control of that site to expand it and grow it, and now we can do that. But the underlying trend in our CapEx remains unchanged at sort of under 100 for the next few years.

Okay. Perfect. And then just back to the margin question. I mean, there's been some - a bunch of talk here on the wing of the future, but it sounds like there might be some more shovel-ready projects in Space & Defense. And I think you called out development tooling kind of as a headwind in this quarter in Engineered Products. How should we think about if there are - if there is a bigger pipeline for Space & Defense, should we think about maybe some margin pressure going forward in that engineered products? Or do you think you can get that segment back to prior peak?

Yes. I mean, we did have a softer quarter, but on top of a very strong first quarter and a very positive sort of engineered product mix in Q1. Engineered Products is lumpy. And anyone who follows Peptel [ph] for some time, we'll kind of have seen that. We do get tooling lumps when we buy the costs we incur and bring this down and then we sell tooling and we get a good mix in a court when we can have a very strong engineered product, it is much more lumpy than composite materials just because of the nature of the business. I mean this quarter was particularly about the CH 63K [ph] but there was also some development nd tooling around some space programs. And I think we believe very strongly in our opportunities for military programs going forward across our engineered core engineered products businesses, we're fantastically positioned to win more business, and we'll be driving to do that.

Perfect. Thank, Patrick.

Thank you.

Thank you. And ladies and gentlemen, we do have time for one further question this morning. We'll take that now from Noah Poponak at Goldman Sachs.

Hey. Good morning, guys.

Morning, Noah.

Good morning, Noah.

Patrick, I wanted to ask about the revenue profile in the back half. I think you alluded to aerospace being down sequentially with the normal seasonality, but it looks historically like that's usually only down low single digits. And I think you're maybe ramping on a number of airplanes. So can you give us a little more context around how much that's down? And then on the defense side, should we be thinking of defense revenues as growing now sequentially from that new level you've put in with this 2Q in absolute dollars? Or with that - does that pull back before then growing again?

Yes. So there's a lot in there. I mean, you're right, we've got underlying program growth, which is - we are going to see some or certainly towards the end of the year, how much of that really materialized in the third quarter, we will see - we will align ourselves with Airbus and Boeing and what they're doing. I think the seasonal expense will be the larger effect, net-net, if you like. And so we will see a bit of a dip. I wouldn't overstate it, but we will see a bit of a step down in Q3. And that in Europe could affect some of the Space & Defense programs as well, quite honestly, it might not just be commercial restate, it could affect Space & Defense. In terms of Space & Defense, Q2 was a record highest ever sort of sales quarter, $137 million, $138 million. I mean, quarter-to-quarter, it's not a straight line. It can be a bit bumpy from time to time, but we're very encouraged and very positive about State & Defense is one of our markets, one of our sectors, and we do continue to see opportunities going forward. It won't be a perfect straight line as I see, but there are growth opportunities ahead, we would expect another good year in 2024.

That's helpful. Appreciate that. And if I could just ask one more on margins. Should we think of next year as kind of settling back into that 25% incremental that has long been sort of normalized for the business? Or are you early enough in getting back to normal capacity utilization and maybe a slower growth in cost inputs that it should be higher than that again next year?

Well, as you know, no, we're not going to call out a specific sort of incremental leverage number or target. We're always going to look to maximize what we can do. Obviously, the last year, 18 months, has been somewhat exceptional coming out of the pandemic, and we've driven very high incremental margins. Quarter-to-quarter, you can get different shapes, different growth profiles and even mixes and costs, as we know. But we will always be pushing ourselves, whether it's 20s or 30s or occasional and 40s, 50s to be lower than that, but we will always be driving to do the best incremental margins that we can perform to.

Oka. Thanks so much.

Thanks.