Hexcel - Q2 2023
July 25, 2023
Transcript
Operator (participant)
Please stand by. We're about to begin. Good morning, ladies and gentlemen. 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 speakers prepared remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press star one on your telephone keypad, and if you would like to withdraw your question, simply press star one again. We do ask that you please limit yourself to one question and one follow-up question.
Now, at this time, I would like to turn the call over to Mr. Patrick Winterlich, Chief Financial Officer. Please go ahead, sir.
Patrick Winterlich (EVP and CFO)
Thank you, Ben. 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.
Nick Stanage (Chairman, CEO, and President)
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 has 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' requirements.
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. Thinking back to the depths 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 backlogs, now at a combined level of over 13,500 aircraft for Airbus and Boeing, are just above the prior peak level. 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. Hexcel is well-positioned to keep winning in this space with our broad portfolio of lightweight solutions. Let me highlight some of the results of the second quarter. 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 on continued robust business jet demand.
Announced orders and options for narrow bodies, 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 site 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 a 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 and 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 and defense is our highest ever. Our space and 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 it 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 ARC Technologies owner. When we recently had the opportunity to buy the property, we gladly 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 by 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 Paris Air Show 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 had 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. 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 their recently announced opening of a new wing technology development center in Filton, 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 goals.
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 this significant moment in our history. I'll turn it over to Patrick to provide more details on the numbers.
Patrick Winterlich (EVP and CFO)
Thank you, Nick. As a reminder, the majority of our sales are 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, 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 and 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% of second quarter 2023 sales.
Industrial sales totaled $52.5 million, decreasing 3.3% compared to the second quarter of 2022, as growth 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. 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 Products 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 CH-53K 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 with the 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 purchase 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 six 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 alternate 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 of our bank's syndicated $750 million revolver. The leverage liquidity covenant calculation is now on a net debt basis. 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 12.5-cent 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 30th, 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-$1.835 billion. Similarly, we have raised and narrowed our EPS guidance range to $1.80-$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.
As a reminder, on sales forecasting seasonality, we typically experience softer sales in the third quarter of the year due to summer vacations, particularly in Europe. With that, let me turn the call back to Nick.
Nick Stanage (Chairman, CEO, and President)
Thanks, Patrick. We are confident that the outlook for Hexcel continues to get stronger, with expectations for significant cash generation in the coming years. 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, though 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. 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 Stamford for our annual strategic review, which is a 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. Bo, we're now ready to take questions.
Operator (participant)
Thank you, Mr. Stanage. Ladies and gentlemen, at this time, if you have any questions, again, star one, please. If you do find that your question has been addressed, you can remove yourself from the queue by pressing star one again. Again, we do ask that you please limit yourself to one question and one follow-up question. We'll go first this morning to Ken Herbert at RBC Capital Markets.
Ken Herbert (Managing Director and Senior Aerospace & Defense Analyst)
Yeah. Hi, good morning, Nick and Patrick.
Nick Stanage (Chairman, CEO, and President)
Morning, Ken.
Patrick Winterlich (EVP and CFO)
Morning.
Ken Herbert (Managing Director and Senior Aerospace & Defense Analyst)
Hey, 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. Can you comment on any other moving pieces that we may or otherwise would have expected to see in the cash flow guide?
Patrick Winterlich (EVP and CFO)
Yeah, sure. I mean, it really was driven fundamentally by that one time, if you like, slightly exceptional capital expenditure to buy the property. That essentially moves us down really from 140 to 100. 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 pushed it to 110. There's not a lot more to it than that. Really recognizing the Amesbury property purchase and some underlying strength.
Ken Herbert (Managing Director and Senior Aerospace & Defense Analyst)
Great. Thanks, Patrick. 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? Does it maybe soften a little bit from where you are today?
Patrick Winterlich (EVP and CFO)
I mean, we've pulled down the seasonality with Q3, and, particularly the European vacations, that will slow things down a little. I think the question really is, how strong is the fourth quarter going to be? Everyone's obviously read about the Raytheon Pratt & Whitney engine issue this morning. There are 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 strongly as possible. 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.
Ken Herbert (Managing Director and Senior Aerospace & Defense Analyst)
Great. Thanks, Patrick.
Operator (participant)
Thank you. We go next now to Gautam Khanna at Cowen.
Gautam Khanna (Managing Director and Senior Analyst)
Hey, good morning, guys.
Patrick Winterlich (EVP and CFO)
Morning.
Nick Stanage (Chairman, CEO, and President)
Morning, Gautam.
Gautam Khanna (Managing Director and Senior Analyst)
I wanted to just ask, in the quarter itself, did you guys see a rate increase on, 737 MAX, A320neo? I know you cited, a couple programs, the A350 and 787 year-over-year, but I didn't know sequentially if you saw much change, across any of the programs.
Nick Stanage (Chairman, CEO, and President)
If you look at the first half, we're clearly aligned with Boeing in the low 30s on the rate. There's a little bit of movement between first and second quarter. Maybe some supply chain restocking happened in Q1. We saw a minimal decrease month sequentially, Gautam.
Gautam Khanna (Managing Director and Senior Analyst)
Okay. Just stepping back, do you feel like, most of the, most of the supply chain, most of your customers are aligned on rate across the, across the board, I mean, with underlying assembly rates at Boeing and Airbus, or is there anyone that's out of whack, noticeably?
Nick Stanage (Chairman, CEO, and President)
Well,
Gautam Khanna (Managing Director and Senior Analyst)
And then-
Nick Stanage (Chairman, CEO, and President)
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. Right now, we see our supply chain throughout the OEMs and the tier one, twos, and beyond, to be pretty much aligned on the product lines that we're providing.
Gautam Khanna (Managing Director and Senior Analyst)
Thanks a lot, guys.
Nick Stanage (Chairman, CEO, and President)
Thank you.
Operator (participant)
We'll go next now to David Strauss at Barclays.
David Strauss (Managing Director, Equity Research – Aerospace & Defense)
Thank you. Good morning.
Patrick Winterlich (EVP and CFO)
Morning.
Nick Stanage (Chairman, CEO, and President)
Morning.
David Strauss (Managing Director, Equity Research – Aerospace & Defense)
First question on margins in the quarter. Could you just maybe touch on the mix, all the different things that might have impacted the margin and Composite Materials in Q2 versus Q1? I mean, the revenue was fairly similar. The margin, obviously, was down a decent amount. If you could address that first.
Patrick Winterlich (EVP and CFO)
Yeah. I mean, I think as we tried to call out in Q1, and I think I've just touched on in those, 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.
With that strong mix of Hexcel fiber products, good sales, leveraging over a controlled overhead base, and combined with some inventory builds, those are 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.
David Strauss (Managing Director, Equity Research – Aerospace & Defense)
Okay. I guess the question on where we go from here, I think previously, Patrick, you talked about mid-teens margins, you know, total margins for the company on $1.8 billion-$1.9 billion in 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. You know, how do we think about the margin progression from here as volumes continue to go higher? Thanks.
Patrick Winterlich (EVP and CFO)
Yeah. 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-$1.9 billion sort of model. I think we acknowledged 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 billion.
Nick Stanage (Chairman, CEO, and President)
... I think, a lot of the inflationary pressures are transitory, energy costs are gonna dissipate certainly as we look forward into 2024. Some of the commodity chemicals and raw materials that we buy are gonna ease off. The general shape of what we put out there is fundamentally correct, but we have been delayed in getting there. As we now approach 2024, and we see our sales are gonna step up again significantly, we will definitely be looking at that mid-teens and maybe slightly higher range for our operating income. 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% OP income that we historically saw, and ultimately, we'll be looking to push past that.
Operator (participant)
Thanks very much. We'll go next now to Robert Spingarn at Melius Research.
Robert Spingarn (Managing Director, Aerospace, Defense & Space Equity Research)
Good morning.
Nick Stanage (Chairman, CEO, and President)
Morning, Rob.
Robert Spingarn (Managing Director, Aerospace, Defense & Space Equity Research)
Nick, I think you just said, or maybe Patrick said it, but you're pretty aligned with Boeing on the MAX in the low 30s during this second quarter. When would you expect to start building to that 38 per month? I have another quick one on future programs.
Nick Stanage (Chairman, CEO, and President)
Yeah, I basically confirm that we are very aligned with Boeing, not only on the MAX, but on the 787, running at about 4, and low 30s on the MAX. You know, we have the capacity. We are ready to ramp up, 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 in 2025, 2026, we're going to be aligned with them. To put a prediction on that, I'll let Boeing talk to that tomorrow.
Robert Spingarn (Managing Director, Aerospace, Defense & Space Equity Research)
Okay, a couple things on Airbus. There's been some talk that the A321XLR 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? You also talked about having brought in your team on future programs, so that must be fresh in your mind. 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.
Nick Stanage (Chairman, CEO, and President)
Rob. To start with, on the XLR, you know, 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 lining that's gonna 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 wanna 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.
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. What I'm so excited about with Hexcel is our portfolio allows us to position multiple material types to help optimize that wing. It depends on the type of ultimate technology that's selected. We believe we're in a great position. We believe Airbus have a fantastic path forward to continue to decrease weight, increase strength, and optimize the future wing for the next new narrow body or any other derivative they move forward with.
Robert Spingarn (Managing Director, Aerospace, Defense & Space Equity Research)
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 narrow body?
Nick Stanage (Chairman, CEO, and President)
I think they have the technology, they could launch a wing 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.
Robert Spingarn (Managing Director, Aerospace, Defense & Space Equity Research)
Great. Thanks, Nick.
Nick Stanage (Chairman, CEO, and President)
You're welcome, Rob.
Operator (participant)
Thank you. We go next now to Matt Acres at Wells Fargo.
Matt Acres (Analyst)
Hey, good morning, guys. Thanks for the question.
Nick Stanage (Chairman, CEO, and President)
Good morning, Matt.
Matt Acres (Analyst)
I guess maybe to put a finer point, could you talk about, you know, the decision to buy the Amesbury facility? What drove that? Was it just that the prior owner was looking to sell, and you wanted to be the owner today? You know, it seems like it wasn't in the original plan for the year.
Nick Stanage (Chairman, CEO, and President)
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. You know, when we acquired Amesbury, or ARC 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., U.S. military product site. The opportunities around what they do and how we can enhance our overall composite offering is tremendous, and our excitement just continues to grow with that site.
When Dan Healey, 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.
Matt Acres (Analyst)
Got it. Thanks. That makes sense. If I could ask on industrial, I know, the wind compares get a lot easier in the back half, but could you just talk about sort of how you think about that business growing sequentially after, you know, to kind of step up sequentially we saw in Q2?
Nick Stanage (Chairman, CEO, and President)
Well, you know, I think we've said before, wind has pretty much stabilized for us in the second half of 2022. Obviously, that's driven by Europe, by the legacy products that we're supporting there. 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 periods on the industrial side.
Recreation has been a little softer on some winter sports and some of the rec goods, but again, that tends to be a little bit impacted by GDP and inflationary pressures. 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.
Matt Acres (Analyst)
Great. Thank you.
Nick Stanage (Chairman, CEO, and President)
Thank you.
Operator (participant)
We'll go next now to Sheila Kahyaoglu at Jefferies.
Sheila Kahyaoglu (Managing Director, Equity Research – Aerospace & Defense)
Thank you. Just wanted to ask on space and defense, good growth in the quarter. What sort of drove that? As you think about 2024, are there any platforms that decline outside the V-22 in defense?
Nick Stanage (Chairman, CEO, and President)
Really, what drove it, the F-35 was very strong for us in Q2. The Rafale was very strong. We saw civil helicopters 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. All in all, it was very broad-based, but those were the primary drivers. In 2024, you know, 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. You know, perhaps some softness in the V-22, but, you know, people have been talking about that going down for a long time, and it just continues to hold strong. I'll wait until we roll up our 2024 plan before I really guide more on what's going to be the puts and the takes in the, in the space and defense side.
Sheila Kahyaoglu (Managing Director, Equity Research – Aerospace & Defense)
Sure. Thank you, Nick. Patrick, if I could ask one for you. I know, I understand you didn'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, you know, buying back shares, what's your sort of metric and analysis you do behind resuming your share repurchases?
Patrick Winterlich (EVP and CFO)
Yeah. I mean, Nick laid out our capital deployment priorities, which haven't changed: the organic growth, disciplined M&A, we'll pay a dividend. Share buyback kind of becomes the default sort of last stock, which we will do. We're not going to sit on mountains, piles of cash. 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 2024 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.
Sheila Kahyaoglu (Managing Director, Equity Research – Aerospace & Defense)
Great. Thank you so much.
Operator (participant)
Thank you. We'll go next now to Pete Skibitski at Alembic Global.
Pete Skibitski (Director, Aerospace & Defense Equity Research)
Patrick, maybe just extending your comments on 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, you know, the carbon fiber mix in three Q versus two Q that could maybe offset it?
Patrick Winterlich (EVP and CFO)
... 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, I'm not gonna 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. As the revenue steps back up, in the fourth quarter, we should be driving back to strong margins again.
Kristine Liwag (Executive Director, Head of Aerospace & Defense Equity Research)
Okay. Thank you.
Operator (participant)
We'll go next now to Richard Safran at Seaport Research Partners.
Richard Safran (Managing Director and Senior Analyst)
Nick, Patrick, Kirk, good morning. How are you?
Patrick Winterlich (EVP and CFO)
Good morning.
Nick Stanage (Chairman, CEO, and President)
Good morning, Richard.
Richard Safran (Managing Director and Senior Analyst)
Nick, since you brought it up, I'd like to ask you about the materials that you were highlighting in Paris that highlighted or enabled the higher build rates. I just want to know if you could discuss what platforms they might be being targeted for, commercial, defense, both? Generally, when you have new aerospace materials, they have a long-term payoff, 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?
Nick Stanage (Chairman, CEO, and President)
Yeah. Again, there's multiple versions, and we're talking about the laydown type, whether it's a prepreg, whether it's an infused product form, whether it's cured in autoclaves under pressure or out of autoclave. We're working all those technologies, and they're on the table, some more mature than others. With respect to the wing and Airbus, and again, you look at the material cost as being one element, but the laydown and 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. With respect to our flexibility and our plants, it makes for a very easy transition. It's just a question of qualification for the application.
Richard Safran (Managing Director and Senior Analyst)
Okay, thanks. Then, Patrick, just a quick one. You know, 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. You know, specifically, I guess, or, inventory. You know, given the expected Q3 seasonal slowing, is it correct to assume that most of your working capital benefit shows up in the Q4? Is that the way it should trend this year?
Patrick Winterlich (EVP and CFO)
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 a corner in the second quarter. Inventory was essentially flat. It was a few million dollars up, but essentially, we stopped the growth that we've seen in the sort of the second half of 2022 and the first quarter of 2023. I would expect that trend to continue and our inventory, in fact, to reduce.
That should drive some working capital reduction and therefore, positive cash flow. Receivables will reflect the level of sales. With seasonality and lower Q3 sales, receivables will probably step down. They're likely to come back again in the fourth quarter. Overall, driven by inventory, I would expect a positive cash flow impact from working capital in the second half of the year.
Richard Safran (Managing Director and Senior Analyst)
Well, thank you very much.
Operator (participant)
Go next now to Kristine Liwag at Morgan Stanley.
Kristine Liwag (Executive Director, Head of Aerospace & Defense Equity Research)
Great. Hey, guys. Patrick, you know, on the Airbus A220-500, or should I say the potential Airbus A220-500, can you provide any color in terms of the maximum shipset content you could potentially win? Is there an opportunity for Hexcel IM fiber for the aircraft? Should you get, you know, the upper end of your expected shipset content, how do we think about CapEx requirements to meet that program?
Patrick Winterlich (EVP and CFO)
Okay, there was a lot of questions in there. Essentially, the A220 today is we call out in sort of $200,000-$500,000 range in terms of shipset. It's probably at the lower end of that range. I mean, if we were to win a significant position, the wing on the A220-100, and we'll be aiming for other opportunities as well, if they re-engineer that platform. Clearly, we see a significant step up in the shipset, I mean, multiple times what we have today. Not gonna try and give a number. It is far too variable, clearly it's a great opportunity. Would it attract IM fiber?
Very likely to attract IM fiber of some sort if there's a wing involved and you need that structural integrity that the IM fibers bring. Again, a Hexcel fiber-rich opportunity would be great. In terms of capital expenditure, I wouldn't foresee 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 Decatur, Alabama, which we put on hold as we went into the pandemic, and I would imagine that capacity, certainly in the next few years, would cover us. Now, if the platform grew significantly, combined with other opportunities, we will gladly invest in capital for strong long-term returns and good margins.
Operator (participant)
Great. Thank you for the color. We'll go next now to Myles Walton at Wolfe Research.
Myles Walton (Managing Director, Aerospace & Defense)
Thanks. Maybe to follow up on that, Patrick, or how much of the sales today within composite materials is supplied or furnished with your own fiber or vertical integration perspective?
Patrick Winterlich (EVP and CFO)
I'll turn that around a little bit. I don't know that we're explicit on that, but we use 70%-80% of our own fiber. The fiber we produce, we consume the vast majority internally. We're not at the full capacity we were in 2019 yet, but it is stepping up, and we are using 70%-80% of what we produce. The remainder goes to third parties, military outlets, and a smaller amount goes to industrial. We use the vast majority of our own fiber.
Myles Walton (Managing Director, Aerospace & Defense)
You, procure from external sources less fiber, I presume, than what you're producing internally?
Patrick Winterlich (EVP and CFO)
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 re-qualified. Yes, we do buy in third-party fibers, but it is a smaller quantity than we use of our own fiber.
Myles Walton (Managing Director, Aerospace & Defense)
Okay. Fair enough. Looking to cash flow, is there a path to 100% net income to free cash flow conversion in 2024, or is the growth going to require.
Patrick Winterlich (EVP and CFO)
The simple answer is yes. We're definitely driving towards that. Whether we'll get there in 2024, I don't know, but we're definitely moving in that direction in the next year or 2, Myles. Yeah.
Myles Walton (Managing Director, Aerospace & Defense)
Okay. Perfect. Those are my only two. Thank you.
Operator (participant)
We'll go next now to Ron Epstein at Bank of America.
Ron Epstein (Managing Director and Senior Aerospace & Defense Analyst)
Hey, good morning.
Patrick Winterlich (EVP and CFO)
Good morning, Ron.
Ron Epstein (Managing Director and Senior Aerospace & Defense Analyst)
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'd want to do, technologies or whatever? I mean, if you could just share a couple words on that, and then I just have a quick technology question.
Nick Stanage (Chairman, CEO, and President)
Yeah, Ron. As part of our STRAT review, obviously M&A and more importantly, technologies around material science is a big portion of our review process. I would say there are technologies out there that are attractive, that would enhance our portfolio, allow us to offer broader solution sets to our customers, whether that's a value add to the materials or sensing 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. We have a pipeline. It'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.
Ron Epstein (Managing Director and Senior Aerospace & Defense Analyst)
Got it. The technology side, when we think about future wings, I mean, that's come up a couple of times here in the context of a, you know, an A220-500 or a future wing, would you expect it to be kind of how they're doing it today with a tape layup? Would you expect it, how, I guess, how the A220 does it, with 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 give us a broad context for that.
Nick Stanage (Chairman, CEO, and President)
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 lightweights, just allows them a great opportunity to optimize the wing. When you're talking about a wing skin versus a wing strut versus a spar versus brackets, really what I believe and what Hexcel's positioned for is it's not going to be one material type. It could be a combination of thermoset, thermoplastic, prepreg, infused, and liquid composite molding. Again, that's the beauty of our diverse portfolio.
Ron Epstein (Managing Director and Senior Aerospace & Defense Analyst)
Got it. Thank you.
Nick Stanage (Chairman, CEO, and President)
You're welcome.
Operator (participant)
Go next now to Michael Ciarmoli at Truist Securities. Hey, good morning, guys. Thanks for taking the questions.
Michael Ciarmoli (Managing Director, Aerospace & Defense Equity Research)
... Patrick, just on, Just back to CapEx on the facility purchase. I mean, you kind of said the path to 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?
Patrick Winterlich (EVP and CFO)
Our CapEx outlook remains unchanged, really. As I think I described it, I would see this property acquisition as a little bit of an exception to our underlying trend. Our underlying trend is to sort of be under $100 million for the next few years. We guided to around $90 this year. I would see a similar shape in the next few years. This building, so to speak, was 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. The underlying trend in our CapEx remains unchanged. They're sort of under $100 for the next few years.
Michael Ciarmoli (Managing Director, Aerospace & Defense Equity Research)
Okay, perfect. Just back to the margin question. I mean, there's been 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 and defense. I think you've called out development and tooling kind of as a headwind in this quarter in Engineered Products. How should we think about, you know, if there is a bigger pipeline for space and 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?
Patrick Winterlich (EVP and CFO)
I mean, we did have a softer quarter, but on top of a very strong first quarter and a very positive sort of Engineered Products mix in Q1. Engineered Products is lumpy, and anyone who's followed Hexcel for some time would kind of have seen that. We do get tooling lumps when we buy it, the costs we incur can bring us down, and then we sell tooling, and we get a good mix in a quarter, and we can have a very strong Engineered Products. 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-53K, but there was also some development and tooling around some space programs.
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.
Michael Ciarmoli (Managing Director, Aerospace & Defense Equity Research)
Perfect. Thanks, guys.
Patrick Winterlich (EVP and CFO)
Thank you.
Operator (participant)
Thank you. Ladies and gentlemen, we do have time for one further question this morning. We'll take that now from Noah Poponak at Goldman Sachs.
Noah Poponak (Managing Director, Aerospace & Defense Equity Research)
Hey, good morning, guys.
Patrick Winterlich (EVP and CFO)
Morning, Noah.
Michael Ciarmoli (Managing Director, Aerospace & Defense Equity Research)
Morning, Noah.
Noah Poponak (Managing Director, Aerospace & Defense Equity Research)
Patrick, 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, I think you're, you know, maybe ramping on a number of airplanes. Can you give us a little more context around how much that's down? 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 Q2 in absolute dollars? Or, you know, would that pull back before then growing again?
Patrick Winterlich (EVP and CFO)
Yeah. There's a lot in there. I mean, you're right. We've got underlying program growth, which we are gonna see some of, certainly towards the end of the year. How much of that really materializes in the third quarter, we will see. We will align ourselves with Airbus and Boeing and what they're doing. I think the seasonal effect will be the larger effect, net, if you like, we will see a bit of a dip. I wouldn't overstate it, we will see a bit of a step down in Q3. That in Europe could affect some of the space and defense programs as well, quite honestly. It might not just be commercial aerospace, it could affect space and defense.
In terms of space and defense, Q2 was our 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 space and defense as 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, and we would expect another good year in 2024.
Noah Poponak (Managing Director, Aerospace & Defense Equity Research)
That's helpful. Appreciate that. 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, you know, getting back to normal capacity utilization and maybe a slower growth in cost inputs that it should be higher than that again, next year?
Patrick Winterlich (EVP and CFO)
Well, as you know, Noah, 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. We will always be pushing ourselves, whether it's twenties or thirties or occasionally, unfortunately, it's going to be lower than that, but we will always be driving to do the best incremental margins that we can perform to.
Noah Poponak (Managing Director, Aerospace & Defense Equity Research)
Okay, thanks so much.
Patrick Winterlich (EVP and CFO)
Okay.
Operator (participant)
Thank you. Ladies and gentlemen, that will bring us to the conclusion of the Hexcel second quarter earnings conference call. I'd like to thank you all so much for joining us and wish you all a great day. Goodbye.