Hexcel - Earnings Call - Q2 2017
July 25, 2017
Transcript
Speaker 0
Good day, and welcome to the Hexcel Corporation twenty seventeen Second Quarter Earnings Conference Call. Today's conference is being recorded. Hosting today's conference are Mr. Wayne Pinsky, Chief Financial Officer and Mr. Nick Stanage, Chairman, Chief Executive Officer and President.
At this time, I'd like to turn the conference over to Mr. Penske. Please go ahead, sir.
Speaker 1
Great. Thank you. Good morning, everyone. Welcome to Hexcel Corporation's second quarter twenty seventeen earnings call on July 2537. Before beginning, let me cover the formalities.
First, 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 press release. Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material, cannot be recorded or rebroadcast without our expressed permission.
Your participation on this call constitutes your consent to that request. With me today are Nick Stannage, our Chairman, CEO and President Patrick Winterlichs, our soon to be CFO and Michael Backel, our Investor Relations Manager. The
Speaker 2
purpose of
Speaker 1
the call is to review our second quarter twenty seventeen results detailed in our press release issued yesterday. Now let me turn the call over to Nick.
Speaker 2
Thanks, Wayne. Good morning, everyone, and thank you for joining us today. As you have seen in last night's release, our second quarter sales were $491,000,000 5.4 percent below our second quarter twenty sixteen sales in constant currency. While overall sales were below our original expectations, thanks to strong operational execution and good cost control, we delivered second quarter operating income of about $90,000,000 with an operating income margin of 18.3. Our adjusted diluted EPS of $0.67 was $03 below last year's record second quarter.
Free cash flow for the first half was a source of $13,000,000 versus a use of $21,000,000 last year, a $34,000,000 improvement. We are now expecting 2017 sales of about $2,000,000,000 in line with 2016 and have lowered our sales guidance accordingly. I want to take a moment to put this revised guidance in context. First, as we have discussed in the past, we are very successful in partnering with our customers on innovative technology and process solutions to optimize material usage, thereby enabling improved operational efficiencies on their end and providing us with a more competitive solution for next generation programs. We undertake an annual deep dive with our customers to update our estimated usage per program.
This is typically part of our strategic planning process, which we are now in the process of completing. Based on our latest review, we are revising our estimated A350 shipset content to $4,800,000 per plane. This is the expected weighted average per shipset of the -nine hundred and -one thousand. The impact on 2017 sales as compared to our initial guidance is nearly $20,000,000 In addition, the inventory adjustments for most wide body aircraft and various business jet programs that we described last quarter extended longer than we anticipated. As result, we now expect 2017 commercial aerospace sales to be slightly lower than our 2016 results.
Our Space and Defense sales are better than initially expected and are now forecasted to be up mid single digits compared to 2016. This increase is not expected to fully offset lower projected wind energy sales. Despite the lower sales outlook for the year, we remain committed to delivering our earnings and cash forecast for the year and are holding our guidance for 2017. That is EPS in the range of $2.64 to $2.76 and free cash flow of more than $100,000,000 Our operational discipline enables us to respond rapidly to these temporary variations in our markets, even as we continue to increase our investments in research and technology to drive next generation advancements and also continue to fund CapEx required for future growth. Lastly, we are benefiting from various tax initiatives as our 2017 estimated effective tax rate is lower than our initial guidance.
Our Board of Directors endorsement of a 13.6% dividend increase reflects confidence in our ability to consistently deliver strong operating performance and generate increasing cash flow. Now let me briefly provide more detail on our markets. As usual, I'll discuss year over year comparisons in constant currency. As you are aware, currency movements influence our reported results, and some of this impact is not intuitive. But the bottom line is that when the dollar strengthens against the euro and the British pound, our sales translate lower while our income increases and so our margin percentages improve.
Commercial Aerospace now accounts for 71% of our total sales. And for the second quarter, these sales were 5% lower than second quarter of twenty sixteen and almost 3% lower for the first half versus last year's first half. Sales growth from the A350, A320neo and seven thirty seven MAX over 2016 were in line with our expectations and offset by legacy wide body rate reductions, supply chain adjustments and productivity initiatives as previously discussed. Sales to other commercial aerospace, which includes regional and business aircraft, were down about 8% from last year's strong first half. The decline was primarily in business jets.
Space and Defense sales for the quarter were about $88,000,000 up 8.4% compared to the second quarter of last year. The increase was driven by growth in all key programs. Rotorcraft sales were at their highest level in two years. Rotorcraft accounts from just more than 50% of Space and Defense sales with more than 85% coming from military sales. Sales for the first half of the year were up 3.5% versus the first half of twenty sixteen.
In Industrial markets, sales for the second quarter were almost $55,000,000 which is 22% lower than the second quarter of twenty sixteen, due primarily to lower wind energy sales. Sales in the quarter were roughly in line with revenues we have seen since the back half of twenty sixteen. We believe twenty seventeen's industrial sales will be more level loaded and our year over year comparisons get easier in Q3 and Q4 as sales for the second half of twenty sixteen were nearly 20% lower than the first half of twenty sixteen. Wind energy sales were down more than 30% as compared to a particularly strong second quarter in '20 '16. While we forecasted wind sales to be lower in 2017, we continue to expect wind energy sales to rebound in 2018 to exceed 2016 levels as various legacy blades with lower composite content transition to longer, high efficiency blades with higher composite content.
Finally, in the rest of Industrial business, we did see continued growth in the automotive market. Now let me turn the call over to Wayne to discuss some of the quarter's financial details.
Speaker 1
Thanks, Nick. For the quarter, gross margin was a solid 28.5% as compared to 28.8% in the second quarter of twenty sixteen. Strong cost control and productivity performance went a long way to mitigate the impact of the lower sales and offset the training and start up costs at our new facilities in France and Morocco. As expected, we had about $5,000,000 of training and start up costs in the first half at these two new facilities, and we remain on track with the construction and start up activities. In addition, depreciation and amortization for the first half was $5,000,000 higher than the first half of twenty sixteen on a constant currency basis, and we expect depreciation to continue to increase in the second half as new additions are placed in service.
For the first half of the year, SG and A expenses were 3% lower in constant currency than the prior year as we maintain tight cost control across all support functions. Research and technology expenses were $25,000,000 in the first half or about 10% higher in constant currency as we continue to invest in innovation to support new technologies, products and process developments. For the quarter, operating income was $90,000,000 or 18.3% of sales compared to the record $100,000,000 or 19.2% of sales in 2016. For the quarter, exchange rates contributed about 70 basis points to twenty seventeen's operating income percentage as compared to 2016. And for the first half, exchange rates contributed about 50 basis points to our results.
Overall, we've done an excellent job of managing headcount. Our total headcount is lower than year end and one year ago, even including the more than 100 people we have in training for the startup of our new French and Moroccan facilities. Our Engineered Products segment comprised of our structures and engineered core businesses delivered 12.9% operating income margin for the quarter as compared to the 12% margin in 2016. To remind you, although margins across the businesses in this segment are lower than those for Composite Materials, the Engineered Products segment employs a much lower level of capital and the return on invested capital for this segment continues to be very attractive. The tax provision was $22,000,000 for the quarter for an effective tax rate of 26.7%.
The quarter included benefits from state tax return to provision adjustments as well as deductions associated with share based compensation payments. The first quarter provision included a nonrecurring discrete benefit of $9,100,000 from the release of a valuation allowance in Luxembourg. Excluding this discrete benefit, Hexcel's first half effective tax rate was 25.7, and we now expect the full year effective tax rate to be around 27% as additional discrete benefits are expected in the second half of twenty seventeen. Free cash flow for the first half was a source of $13,000,000 as compared to a use of $21,000,000 in 2016. Working capital decreased $33,000,000 in the quarter, resulting in a use of $7,000,000 in the first half of twenty seventeen as compared to a $72,000,000 use in the first half of twenty sixteen.
The primary driver was an improvement in receivables due to lower sales and continued strong collections. We do have seasonal fluctuations in our free cash flow with the second half tending to be a significant source of cash compared to the first half. Cash payments for capital expenditures was 169,000,000 for the first half. The midpoint of our CapEx guidance for the year is $280,000,000 So we have now spent about 60% of our 2017 capital expenditure plan in the first half of the year. Our capital expansion program is currently quite active as we are in the process of starting up new carbon fiber and pan lines in The U.
S. As well as being fairly far along and completing our greenfield sites in France and Morocco. As previously announced, we still expect that 2016 was our peak year in the current cycle of capital investment. 2017 will see modestly lower expenditures as we just discussed, followed by much lower spending in 2018 and 2019. During the quarter, the company used $57,000,000 to repurchase shares of its common stock, bringing our buyback program for the year to a total of $121,000,000 We now have $272,000,000 remaining under the authorized share repurchase program.
Before I turn it over to Nick for some final thoughts and before we take your questions, I would like to make a few personal comments. As many of know, this is my last earnings call as CFO. We spent a lot of time on management development and succession planning. And as a shareholder of Hexcel, I'm pleased to say we got this transition right. I couldn't be more pleased that Patrick was chosen to succeed me.
Patrick is a longtime Hexcel employee with broad experience in finance, operations and IT, and he knows the business better than I do. I have no doubt that this will be a seamless transition since Patrick has been a member of our leadership team for years and has been involved in part in the decisions we've made in recent years. The overall passion and industry knowledge at Hexcel is second to none. It's been a great team to work with, and I wish the best for the company going forward as it continues its journey to build on its world leading position for innovation, advanced composite market growth and operational excellence. In fact, I'm counting on it.
Speaker 2
Thanks, Wayne. By staying aligned with customer demand while keeping costs under control and operational excellence at the forefront, we delivered a solid start to 2017. We are committed to achieving our earnings plan for the year and remain bullish on the long term. Our performance this quarter demonstrates our operational discipline to respond rapidly to changing circumstances as well as our strategic commitment to ongoing investments in research and technology, acquisitions and funding CapEx required for future growth. I also want to remind you of our announcement during the second quarter that we have reached agreement with Safran to acquire their Structal business, and we expect this to close later this year.
As with our other investments and acquisitions, Structile will bring leading edge composite technology that will further enhance our strong portfolio, particularly in the areas of adhesives, prepregs and pultrusions. Before opening it up for questions, I'd like to personally thank Wayne for his tremendous support and contributions throughout his twenty four year Hexcel career, and I'd like to wish him and Kim all the best in retirement. Lauren, we now welcome questions.
Speaker 0
Thank you, sir. You. We'll take our first question from Myles Walton with Deutsche Bank.
Speaker 3
Good morning And congratulations to your
Speaker 0
retirement,
Speaker 3
Enjoy maybe just to start off the obvious. So you've lowered the sales guidance here again. In last quarter, I think $20,000,000 of the lower sales guidance was due to the legacy widebody destocking. And it looks like a similar amount here.
So it doesn't look like it's slowed down at all. Is that right? So $20,000,000 is effectively the year of rebasing of the A350 million and another $20,000,000 is continued destocking?
Speaker 2
Okay, Myles. So you're close. On the first quarter, revised our guidance down about 80,000,000 FX, 20,000,000 or approximately 20,000,000 on the $777,000,000 and then about 20,000,000 on destocking or inventory supply chain adjustments. The second quarter is really made up of approximately think of it approximately shipset related A350 volume, 20,000,000, approximately $10,000,000 on supply chain and approximately $10,000,000 on a net between the negative headwind on wind versus the positive in space and defense. So we have seen the supply chain slowdown.
And given our view on the backlog and working with our sales team on what's forecasted in Q3, we do think it has tapered off and majority of it is behind us.
Speaker 3
So you've also, I think a couple of quarters ago, talked about double digit growth into 2018. And I'm just curious given what you're seeing on the ground now and the destocking you're seeing, are you looking more at a high single digit level of growth? I know you reiterated your industrial business sales target, but I'm curious on your other two.
Speaker 2
Yes. So again, we'll give specific guidance updated guidance towards the end of the year. But fundamentally, we remain very optimistic on 2018 with regards to continued growth with the A350, the narrow bodies, which continue to not only grow, but the rates are continuing to go up. Upside on the military with very strong performance on JSF, A400MV22 Blackhawk and then a big rebound in wind going into 2018. So a little early for us to really get too zeroed in on the exact numbers, but next year is going to be good.
Speaker 3
And one last one. So you'd lowered the shipset content based on kind of roll up. So does that mean it wasn't based on negotiation with the customer, it was based on recalibration of what you're actually seeing go out the door for each aircraft?
Speaker 2
Yes. This topic warrants a little bit of a discussion. So I think we're going spend a couple of minutes on it. So in general, every year, as part of our strategic planning process, we work with our customers and we understand the best we can on what material goes to what customer for what application. So you got to keep in mind, we're shipping materials in multiple forms that can go in all different directions.
Let's just talk about the A350 alone. We have 60 ship to locations with various material forms. So through strat process, we work with our customers, we look at their usage in the plants, we look at their inventory levels. And then when we get to plan, we basically build our plan with our customer forecasted orders and what they're telling us they need to buy. We then check that, do a sanity check with our chipset, and we tweak that and adjusted it continually.
So we're always working with our customers, number one, to find new opportunities to replace heavier parts, weaker parts with advanced composites. So we see application increase and our number go up. We also work with our customers on productivity initiatives, finding ways to reduce scrap, waste within the supply chain, and that affects us on the downside short term, but helps us position our materials much more competitively for the long term. So to get back to your question, had nothing to do with customer negotiation. At the end of the day, it was good productivity work with our customers to help them be more competitive and help us position our materials for future opportunities.
Speaker 3
All right. Thanks. I'll leave it there.
Speaker 0
Next question from Gautam Khanna with Cowen and Company.
Speaker 4
Yes. And I echo Miles' sentiments to you Wayne. Best of luck. It's been a pleasure to work with you.
Speaker 1
All right. Thanks Gautam.
Speaker 4
So to that point that Miles just raised, is there a I mean, do you think the A350 content you guys will have is going to continue to shrink over time?
Speaker 1
And if so, sort of
Speaker 4
what is the limit? And any thoughts there? And then I'll follow-up.
Speaker 2
Well, I'm certainly and the team is certainly working to increase the shipset content. So there's no doubt we're focused very intensely on new opportunities, new applications. Now as an aircraft matures and you get into a steady state production, the likelihood of introducing a change becomes less. So it does tend to stabilize. Having said that, I'm hopeful we can continue to find opportunities to make our materials more competitive, but I don't see a dramatic move here.
Speaker 4
Okay. And was the reduction largely the function of yield improvement downstream, I. E, people are cutting the parts a little more efficiently? Or what actually drove the reduction?
Speaker 2
Well, I don't know that there was one item. Clearly, we're always working to help reduce scrap in the supply chain. That was one element. The technology has continued to evolve. So if you look at when the A350 was developed and the first parts were made, we have more efficient ways of making some of those materials.
So some transition to a new higher technology, more efficient material form, some in scrap reduction and throughput rate reduction. So it really was a combination, not one factor.
Speaker 4
Okay. But we should consider it a reduction and also profit, right? It's not like you keep the value of the technological leaps that are allowing you to save your customers money. Is that right? So a lower profit dollar on the A350 is expected
Speaker 2
just we look at it as it may impact the sales, but we're always pushing to enhance and expand our margins.
Speaker 4
Fair enough. And just one last one. In terms of the destocking across a number of the programs, how broad based is it within the subcontract manufacturers that you supply to? Is it isolated to one or two of the subcontract manufacturers you sell to? Or is it broad?
And how confident are you that it's not going to spread, I. E, some people are hesitant and some people are still behind? Yes.
Speaker 2
Well, do think it is fairly broad. It's not one or two driving it, whether you're talking about Airbus or whether you're talking Boeing. And again, remember, the supply chains are extremely complex with 60 plus for the A350 and similar types of numbers on other programs. And each one of these can be at different points in the part assembly process for the final aircraft. So there's a lot of variation there.
So again, we think we have very good insight, although not perfect. We'll continue to refine it and try to get better. Our backlog view helps us gain confidence that the supply chain corrections are subsiding, and we're really getting to a more steady state position. That's basically where we think we are today.
Speaker 4
Thank you, guys. Thanks.
Speaker 0
Our next question comes from Howard Rebel with Jefferies.
Speaker 5
Thank you very much. Patrick I think Wayne set a heck of a high bar for you but I'm sure he knows that and you guys will do well. And Wayne, it's been a pleasure.
Speaker 4
Thanks, Howard.
Speaker 5
Thanks. Thank you very much. Nick, you know, you talked about going through this study on product and looking at the change in volume. How does that play through to the capital spending plans that you're working on?
Speaker 2
Yes. That's a great question. As Wayne said, we're still on track for our midpoint this year of $280,000,000 and then pretty substantial drop over the next couple of years with a total of $320,000,000 Howard, we've got what I think is one of the best in class capital management organizations and processes. And I tell you, every day, we look at our spend versus the demand, and it's continually tweaked. So having gone through our strategic internal strategic review and getting ready for our Board review this fall, we still feel very good.
We do not see anything that changes. Matter of fact, there are some areas we're actually accelerating some of our CapEx. I'm thrilled with the fact that we're bringing online our assets in Salt Lake City and Decatur. And very soon, we'll have our assets in Roussillon and Morocco up, and we'll get that headwind behind us. As you know, that's been roughly $5,000,000 for the first half of the year, and it will taper down in Q4.
But at the end of the day, I still feel good about our CapEx spend. It's still required. And again, I love having our assets running 100% filled, and that's what we have line of sight to.
Speaker 5
But you basically said you're well, I'll use the word debottlenecking and your suppliers have done the same thing. And if we just look at the $350,000,000 and sort of spread it across a number of other opportunities, wouldn't it really say that as you scrub your plan or as you scrub your volume demands that there is some lower capital requirement for the enterprise because it's got productivity and other factors. And we might not see it this year, I recognize that, but next year and the year after, it should have some spill.
Speaker 2
Absolutely right, Howard. And I can tell you we have various small and even a few very large programs that can significantly change our go forward capital profile. When we talk about R and T investment, that's a combination of material science, chemistry as well as new processes and manufacturing technology. So that's a big focus for us because you know how expensive these capital assets are and the long cycle time we have. So the more efficient we can make those investments, the broader we position our materials for entitlement and positioning for new programs.
Speaker 5
And so your acquisition of the small saffron business in talking to you folks looks like it has some pretty interesting and unique capabilities that I'll just call it you can drop into your portfolio and offer multiple solutions to a host of customers. How fast do you think you can integrate it? And when do you think it could turn into something that's more than just a modest contribution to results, Nick?
Speaker 2
Well, Howard, I have to give you credit. You summarized the benefit and why we bought this perfectly. The overlap is almost nonexistent. It fits right into our core. It provides qualifications and technology that enhances our position.
So we're thrilled with this. I can tell you we have a team on the ground. We're already into our integration plans and how we're going to organize structure. We're already looking at sales synergies and a few transitions that are going to help us. Now to put some numbers around what it could mean going forward, I need to buy a little more time for us to really get in there.
Otherwise, I'd be afraid I'd understate it.
Speaker 5
Ouch. Just two quick questions. One is, did I hear you say or did Wayne say tax rate for the year on a reported basis would be 27%? Or was it another number? I'm sorry.
Speaker 1
No, Howard, that's correct. The 27%, but that excludes that first discrete benefit the discrete benefit in the first quarter of $9,100,000 So the GAAP rate is a little bit lower.
Speaker 5
And then thank you. And then finally, Nick, you talked about auto being a little bit better or larger. Is it new platforms? Or can you elaborate a little bit on the forward look that you have there?
Speaker 2
Well, auto has I have to go back and look quarter over quarter has done very well. On a percentage basis, very nice double digit growth on a very small base. So Howard, we continue to look at niche opportunities with some of our key customers, including BMW, the -seven. B pillar continues to do very, very well. Our roof business continues to do very well.
And then we're being successful in various other pursuits. So it's a combination. Still feel good about it. I'm really excited about the technology that the team is working with respect to production rates, snap cures, manufacturing processes that just help us become even more competitive against the metals.
Speaker 5
Thank you all gentlemen.
Speaker 2
Thanks, Howard.
Speaker 0
Our next question comes from David Strauss with UBS.
Speaker 6
Thanks. Good morning. Congrats Wayne and thanks for all the help over the years.
Speaker 1
Thanks, Nathan.
Speaker 6
I wanted to ask about narrow body rates. In Q2, did you see the full impact of the higher narrow body rates this year actually flow through your numbers?
Speaker 2
Well, I can tell you, we on the Neil and the Max, we actually were slightly above our forecasted sales. So we did see that come through. We do believe there's still some transition between 320neo and CO based on engine ramp rates. But working our numbers back on what we're shipping in materials based on the rates that they're climbing to, which I believe, Wayne, this year is 47,000,000 for the $737,000,000 and
Speaker 1
100,000,000
Speaker 2
for the A320, we believe we're aligned.
Speaker 6
Okay. All right. Great. And in terms of your what you've talked about for 2018, what do you I know A350 isn't big volume numbers, but you've got a pretty high shipset content there. What had you kind of been thinking on A350 when you had made those comments on 2018?
Well,
Speaker 2
we're in the do I take about three eighty or are talking about three fifty?
Speaker 6
Sorry, yes, three eighty, sorry.
Speaker 2
The three eighty million So
Speaker 1
you know, David, they dropped from two a month down basically down to one a month. And our assumption is that's what we're expecting for 2018 now. I suppose there's a little bit of risk in that number, but essentially be flat with this year.
Speaker 6
Okay. And then I guess the same question on $350,000,000 if your view has changed or modified at all in terms of the I think you've been talking about previously getting to 10,000,000 a month by the end of twenty eighteen. Is that still your current thinking?
Speaker 2
Yes, it is. We think we're right around 8 and we'll ramp up sometime mid second quarter, third quarter next year to the 10.
Speaker 6
Okay. Wayne, last one's for me. Obviously, tax rate is running lower this year. I think the last several years, you've had some items that it's allowed to come in lower. How should we think about tax rate in 2018?
And then also any potential impact from the change in the revenue recognition standard?
Speaker 1
Okay. So with respect to 2017, just to remind, we went in expecting a 30% effective rate and we're now expecting about 27%. Three % is worth $10,000,000 or $0.11 So it's been a meaningful contributor to this year. A lot of that difference between $30 and $27 some of it will carry over into next year, but most of it won't. So we're not ready to opine on the 2018 tax rate.
But if you're thinking don't think $27 think towards $30 no absent any change in tax rates. With respect to revenue recognition, we're firmly committed to adopting it on 01/01/2018, and we'll advise of any impact later on. But it's not obvious to us that there will be a significant impact, but we're in the heavy midst of going through the implementation process now. But I'd say we're hopeful that there's not a big impact.
Speaker 6
Thanks a lot.
Speaker 7
Thanks, David.
Speaker 0
We'll go next to Robert Stallard with Vertical Capital.
Speaker 8
Thanks so much. Good morning.
Speaker 1
Good morning.
Speaker 8
And Wayne, I'll echo everyone else's comments. Hope you have a great retirement. Before you go, we've got a couple of questions for you.
Speaker 1
First of all,
Speaker 8
it's not I can't let you go too easily. First one is inventory destocking that's been going on. You mentioned there's lots and lots of different customers you're talking about here. What's your sense that the reduction is only to bring it down to current rates rather than anticipating any further production cuts that could be coming on things like say July?
Speaker 1
Yes. So I mean, guess, you step back and say, why are we having destocking in the first place? It really is about most of it the legacy widebody rates being reduced. So remember, you got the think about in last year, you've had seven seventy seven going from 8.3 a month to seven to five on its way to 3.5. And so we probably accounted for the build rate drops, but you also have that destocking as you go through it because people need less inventory.
And the same for the A330 has dropped down, the seven forty seven has dropped down, the A380 has dropped down. So it's really all those. Now to your point, do we know whether the drop down system reflects the new rate or is it beyond that? That's probably beyond our scope to figure that one out. But in general, that's really why it's happening so much this year as opposed to any other year.
And I guess the last one I'd add just is the 787s probably one in that latter category where there isn't been a drop in rate, but there's been a steadying of rate. And now that they've been at 12 a month for a while, I think everybody has been able operate much better and more cleanly and therefore you've seen some inventory go down there.
Speaker 8
Okay. Nick, you had some pretty positive comments about wind heading into next year. I was wondering how much of this optimism is reflected in the orders of the backlog that you currently have or whether that still has to flow through the system?
Speaker 2
So if you look at Vestas backlog, it's strong. Their performance continues to be strong, and we're working with them daily. They've recently announced some of their new blade launches, which we're excited about. And those are some of the exact blades where they're bigger, they're longer, they're more efficient and we have significantly more content. So I am not betting against Vestas.
They're doing very well. They're still the market leader. And they're going to require our materials to ship those turbines. So we feel very good. Now the timing and how quick the ramp up, again, we'll refine that as we get into latter part of the year and provide our guidance.
But everything we're seeing with respect to Vestas efforts, with respect to their positioning, their plants, we're getting ready for the upswing.
Speaker 8
Okay. And then just a final one from me. I was wondering if you could give us any update on any discussions you might be having with Boeing or related customers on a mid market aircraft and what the materials could be on that plane?
Speaker 2
Well, I always am careful about what we're talking to our customers about specifically. I can tell you we're very excited with some of the communication and increased excitement around the new aircraft announced during the or at least positioned during the air show and also some of the derivative type platforms that could follow as well. So I can tell you, we're actively working with the engine manufacturers, the nacelle manufacturers and the primary OEs on new materials, new solutions, new options for next generation platforms. So we're it's not officially launched. We're hoping that happens.
We'll be ready when it does happen and look forward to capturing more than our fair share of content.
Speaker 8
That's great. Thanks so much.
Speaker 1
Thanks, Rob.
Speaker 2
Thank you.
Speaker 0
We'll go next to Robert Spingarn with Credit Suisse.
Speaker 9
Hi, good morning and congrats Wayne and Patrick.
Speaker 7
Thank you. Thanks.
Speaker 9
I wanted to go back. I think Gautam asked you the question on the lost sales and in the context of lost profit. You held your guidance, but you have this $0.11 I think it's an $0.11 tailwind from from tax. So clearly, there was some lost profit. Does it allocate the same way that the sales guidance, you know, in the same proportions as the sales guidance decrease?
Or or do you have greater decremental margins in certain things than others?
Speaker 1
No, Rob. I guess in general answer to your question, it's proportional to the drop in sales. But that's not easy to do. We've had to do an excellent job of controlling the headcount as we talked about to make sure we dropped. I mean, of the things we do well is respond to the drop in sales and we did that accordingly.
We don't have a lot of discretionary spend, but the limited amount we have, we've done a good job of balancing there. So we've been able to offset it proportionally, so we didn't get incrementally hit harder than that.
Speaker 9
Okay. All right. So about average margin. So moving on, this was asked about earlier as well. There a natural decay is maybe the wrong word, but decline in the buy to fly ratio for composites over time that we could use as a rule of thumb.
So I understand that you said in some cases, your content rises, but it sounds sounds like that's because scope would increase. But what I'm talking about is just greater efficiency on the part of your customers where you just have to build in some expectation of shrinkage over time.
Speaker 2
Yes. I think you summarized that quite well. I mean productivity is here to stay for everyone, not just us. I mean you can see Airbus and Boeing and for that matter, everyone in the space are looking to drive profitability up, recognizing that they have to get costs down and get more productive. And what that means is use materials more efficiently, reduce scrap rates, increase cure times, cure time speeds.
So to give you a general number is very difficult to do given the complexity of the supply chain. I would say the more mature a program is, the more it is learned and the less likelihood there would be adjustments. Whereas a new program that's ramping up like the seven eighty seven or A350, there tends to be a little bit more opportunity on the front end as customers in the supply chain get more accustomed with handling materials, they get more efficient. And it certainly has a curve to it and a slope to the level of opportunity and improvement while staying within the qualification window because that's really where the difficulty comes in deviating from the qualification window and making major changes.
Speaker 9
Okay. And then Nick, if I could just ask you going back to the seven ninety seven discussion. I know you don't want to get too specific. And frankly, I don't know how specific your customers got yet. But could you give us some sense of what new technology means relative to the composites that are out there on today's platform?
How significant a leap are we talking about that maybe puts you into the contest on for a customer where you haven't where one of your competitors has dominated in the past?
Speaker 2
Yes. So again, I know what we read in the magazines. And I think Boeing on the NMA or seven ninety seven, whatever you want to call it, they're really leaning toward a unique configured fuselage. And I believe they've declared or they're close to saying it will be composite, which was music to our ears. We've always been trying to position our materials to maintain those positions.
Clearly, the material choice has not been made. What gives me great hope and optimism is the multiple opportunities and options we're providing. So when you think of technology advancements, the next generation aircraft, my belief, will have materials that are lighter, are stronger and will be much more efficiently made, I. E, the cure rates will be faster. They may or may not use an autoclave, which will reduce capital for the customer base.
The cure rates will be faster. So overall, not only the materials will be advanced or a derivative of what's existing, really the manufacturing processes will go to the next level.
Speaker 9
Okay. And is Hexcel positioned better for the material or the manufacturing processes? What are you going to lead with?
Speaker 2
Well, we're certainly working the material side, but we're working with manufacturing equipment designers and makers to make sure our materials are ready for those. It's really a combination. The material and the processing equipment design for that material have to work hand in hand, and we work integrally with them throughout the process.
Speaker 9
Okay. Thank you.
Speaker 4
Great. Thank you.
Speaker 0
We'll go next to Noah Poponak with Goldman Sachs.
Speaker 10
Hey, good morning everyone and congrats Wayne and Patrick.
Speaker 1
Thanks Noah.
Speaker 10
Can you guys elaborate on what drove the upward revision to the defense revenue growth guidance?
Speaker 2
Well, I can tell you the our key programs were all up nicely. JSF probably the biggest, although A400M, B22 and the Blackhawk was up nice. Rotorcraft in general rebounded on the military side and even the commercial side was sequentially up. Still year over year, it's a fraction of what it was in 2016. But it gives me hope that maybe on the commercial side, we've turned the corner.
So I think you just look around and you read and you see what others reporting, there's a lot of optimism in the space and defense market. I know some of that optimism and excitement will take time to transition down through the supply chain and translate into hard sales. But the programs we're on are very good. We're seeing great growth projections going forward. And I'm looking forward to doing our roll up for 2018 plan and having good news to share with everyone.
Speaker 10
Yes. So maybe on that point, I mean, you have the 3% to 5% CAGR for the segment through 2020. And I know you just mentioned looking forward to doing the roll up, it's a long cycle business where you have some visibility. Would you be willing to maybe speak to where you're preliminarily seeing 2018 shake out versus that range? Just because 2017, we're now talking mid single digit and you have a negative quarter in it.
You've got another big step up in JSF next year. You just mentioned the easy comparison at least in the commercial helicopter side. It would seem like there's decent prospect for being ahead of that range in 2018.
Speaker 2
Well, I sure hope you're right. I sure hope you're right. I would tell you, you have to keep in mind the fact that we're on 100 plus programs. And remember, a lot of these volumes in aircraft terms or platform terms are relatively small volumes, and it tends to be lumpy. So I don't want to get ahead of ourselves and talk about what we're seeing in Q2 being the trend long term.
I am optimistic and I sure hope we can give you a number above our prior range for guidance going forward. But again, it's just a little earlier than I want to declare.
Speaker 10
Okay. And then just lastly on margins. I know you've said you still have a 25% incremental running through the business on an underlying basis, but 2017, it's not going to be that way on a reported basis given the FX moves and the investment changes. How should we think then about how 2018 margins compare to 2017 margins as those items normalize?
Speaker 1
So with respect to incremental margins since 2017 sales are going to be flat with 2016, it doesn't become exactly a meaningful number. I'm hoping that you're right on 2018 sales and the bigger the sales increase, obviously the easier it is to hit the 25% target. We're not backing off of that and we fully expect to do it on as long as there's meaningful sales increase.
Speaker 10
Wayne, have quantified in millions of dollars what exactly how much is hitting the P and L this year for investment that doesn't recur beyond this year?
Speaker 1
I'm sorry, you're talking about the start up of new facilities or you're talking about depreciation?
Speaker 10
I'm talking about either of those or really anything that's unique to this year.
Speaker 1
Yes. So depreciation going up, is it unique to this year? I mean, we've had it this year, last year and we'll have another big increase step up next year as well. But obviously, we'll have more assets to use and hopefully, we'll be up and generating revenue. With respect to the two start up locations, when Nick mentioned, it's $5,000,000 for the first half of the year and we expect that run rate to taper as we go into the fourth quarter.
But hopefully that doesn't recur at that magnitude next year.
Speaker 10
Okay. Thank you.
Speaker 4
All right.
Speaker 1
Thanks Noah.
Speaker 0
We'll go next to Chris Kapsch with Aegis Capital.
Speaker 7
Yes. Good morning. A couple of questions. On FX, and I apologize if you touched upon this, but the dollar suddenly weaker vis a vis the euro. Just remind us how hedged you are for the balance of 'seventeen and perhaps 'eighteen?
And then also just have you provided an approximate op income EBIT sensitivity to FX? And I realize we're talking about primarily the euro and to a lesser extent, guess, British pound.
Speaker 1
Right. So Chris, with respect to the second half of the year, we're hedged enough and there's not that much time remaining in the year that most movements of the euro and the pound for the last six months are going to have a whole lot of impact on our operating income. They will impact the sales translation, but with respect to operating income, probably not much. As you go into next year, we're probably 50%, sixty % hedged at this point. And if the rates get worse, that'll hurt next year a little bit as we continue to hedge into it.
But think about it this way, we hedge out 10 quarters and we sort of we roll in every quarter roll into that number. So we're not completely hedged to where we want to be for 2018, but we're fairly far along.
Speaker 7
And is there a sensitivity number assuming kind of an unhedged environment?
Speaker 1
Yes. So think about yes, just an order of magnitude, think about and this is the combination of the euro and pound together. We're at about 200 at the operating income line, we're about $250,000,000 of exposure. So if we had no hedges and the rates moved 10%, that's a $25,000,000 impact. But that's the size of the magnitude we're trying to hedge.
Speaker 7
Okay. And then just a follow-up on this discussion about efficiencies that are now being passed along. I guess your commentary suggests that those efficiencies are mostly in the form of material, reduced scrap, maybe less content. But I would have thought maybe some of that is also just pricing that you might pass along as particularly for the advanced programs as the production volumes ramp, they achieve certain thresholds. They might hit price points where you pass along efficiencies in the former price.
So but I think what you're saying is it's more the former, not the latter. Could you just elaborate on that? And also discuss any implications associated with whether it's material or pricing that is being passed along and described as efficiencies? Thank you.
Speaker 1
Chris. So just to be clear, it's not price. Having said that, just to also be clear, when we've given out shipset content, we've given it at the price when it's at the highest rate and therefore the lowest price. So that price hasn't changed and that's always been built and whether it was $5,000,000 or $4,800,000 So the change between the 5,000,000 and 4,800,000.0 does not have anything to do with price.
Speaker 7
Okay. And then, I mean, this enough that it would affect your anticipated margin profile as you ramp up the assets that are being used to produce these advanced materials for some of these key programs like the A350?
Speaker 1
So on a margin percentage basis, we're trying to hold on to as much margin dollars as we can as it's gone down. Having said that, as a margin percentage, we don't expect it to get worse. Whether it gets better, that's obviously our goal. But we don't expect it to get worse.
Speaker 7
Okay. Thank you.
Speaker 1
Thanks, Chris.
Speaker 0
And that's all the time that we have for questions today. Thank you for joining the call. We appreciate your participation. You may now disconnect.