Hexcel Corporation (HXL) Q2 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. My name is Brent and I will be your conference operator today. At this time, I would like to welcome everyone to the Hexcel Q2 2022 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. It is now my pleasure to turn today's call over to Mr. Patrick Winterlich, Chief Financial Officer. Sir, please go ahead.

Thanks, Brent. Good morning, everyone. Welcome to Hexcel Corporation's second quarter 2022 earnings conference call. Before beginning, let me cover the formalities. I want to remind everyone about the safe harbor provisions related to any forward-looking statements we may make during the course of this call. 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 2022 results detailed in our news release issued yesterday. Now let me turn the call over to Nick.

Thanks, Patrick. Good morning, everyone, and thank you for joining us today as we share our second quarter 2022 results. We started the year with great momentum and carried that forward into the second quarter. Hexcel delivered consistent, sustained performance and solid results, while overcoming significant macroeconomic challenges, including supply chain constraints and inflation. With almost 50% growth in our Commercial Aerospace sales year-over-year, we are confident that the pull for lightweight advanced composites for next-generation aircraft is strong where older muddle aircraft remain parked and backlogs continue to grow for lighter, more fuel-efficient and aerodynamic aircraft that are content rich with our innovative technology. The strength of the post-pandemic aerospace recovery is very good news. We are experiencing strong upticks in build rates in commercial aerospace and business jets. The Space & Defense market has remained robust throughout the pandemic and is showing signs of further strengthening. We are also seeing growing demand for Composite Materials in industrial and recreational markets. At the same time, our production facilities are faced with rising energy prices, higher costs for some raw materials combined with the constrained supply chain resulting in extensive global logistical challenges. Along with a tight labor market and less experienced new employees, there are headwinds to our efforts to meet this exceptionally strong demand. These challenges are not unique to Hexcel, however, I'm confident in our ability to manage through the uncertainties and exciting times ahead. As you well know, operational excellence is a core focus for Hexcel to streamline processes, drive productivity and work more efficiently. During recent years, our teams have delivered significant cost reduction through continuous improvement projects for the benefit of our customers and for Hexcel. We are continuing aggressive actions, yet with inflation in the US and Europe at historically high levels it is challenging to rapidly offset the immediate inflationary impacts through process and productivity enhancements. However, we remain committed and will never relax in our efforts to address and overcome these headwinds. The keys to our continued success throughout the pandemic and even now as we address its aftermath our alignment and transparency with our customers and suppliers as well as our ability to pivot and flex as our markets dictate. We'll remain vigilant and agile giving us a tremendous competitive advantage as we work through the current uncertainties. With every situation we face, Hexcel remains focused on staying aligned with our customers and delivering on our commitments. Now let's turn to some specifics reported in our earnings release last night. Second quarter sales of $393 million were about 26% higher in constant currency compared to Q2 2021. Second quarter adjusted diluted EPS was $0.33 compared to $0.08 last year. Commercial Aerospace sales of about $230 million were up 49.5% in constant currency led by growth in the A350, A320neo and 737 MAX programs. This is the fourth consecutive quarter of double-digit sales growth in Commercial Aerospace. As the market recovers, Hexcel benefits from the continued penetration of lightweight composite materials as well as our relentless commitment to partner with and serve our customers. Business jets and regional aircraft sales increased more than 75% for the second quarter of 2022 compared to the second quarter of 2021. When it comes to business jets, we continue to see growth for Hexcel. Our content on some of the new large cabin business jets falls in the previously disclosed range of $200,000 to $500,000. Reflective of that is the recent long-term agreement we announced this month to supply carbon fiber prepreg for the composite rich Dassault F10X large cabin business jet. It reaffirms our strong partnership with Dassault. While we are always pleased to announce new business, this particular selection represents a milestone in that it is the first Dassault business jet program to incorporate high-performance, advanced carbon fiber composites in the manufacture of its aircraft wings. Thanks to Hexcel Carbon Fiber Solutions, the wide high-speed wing will be made for maximum strength, reduced weight and minimum drag leading to enhanced performance and fuel efficiency. The Falcon 10X is planned to enter service at the end of 2025. Also, let me mention a couple of other highlights during the quarter. For the third consecutive year, our team at Casa Grande, Arizona has been recognized by Boeing with its silver supply chain performance Achievement Award for achieving superior supplier excellence. Hexcel is the world's largest honeycomb producer for the aerospace industry and much of it is produced at our Casa Grande site. In June, we celebrated with Airbus as a 321XLR completed its maiden flight. Hexcel is a major supplier of advanced composite materials for the aircraft as well as the composite-rich CFM LEAP and Pratt & Whitney geared turbofan engines powering this newest variation in the A320neo family. Our lightweight composite materials provide weight savings and performance enhancements that reduce fuel consumption and emissions as well as long-term maintenance costs. Turning to Space & Defense. Sales of about $112 million represented a 7% increase in constant currency. We are experiencing continued growth including the new CH-53K heavy lift helicopter, space programs and a number of international programs. In June, we announced a long-term agreement to supply advanced composite structures for the CH-53K King Stallion heavy lift helicopter program. Currently, Hexcel supplies carbon fiber prepregs, honeycomb and rotor blades for the CH-53K. Under this new agreement, we will also supply composite structures for production of the cargo ramp and aft-kit components with the first delivery of these parts expected to Sikorsky in 2023. The award significantly expands Hexcel's composite content on the aircraft where our shipset value is between $2.5 million and $3.5 million depending on whether we provide the blades or those are built in-house by Sikorsky. This award recognizes Hexcel's leadership in producing high complexity aircraft structures at our Kent, Washington site. You will recall that in 2021, we announced plans to transition Kent toward more advanced composite production and higher value-add growth programs and this additional work is representative of a successful and ongoing transition. I also want to mention how exciting it is to see the first set of full-color images taken by the James Webb Space Telescope and released by NASA this month. As you know, it is the largest the most complex and the most powerful space telescope ever launched and Hexcel advanced composite materials not only support its critical structure, but also we're onboard the Ariane rocket that launched it in the space. We congratulate both NASA and Northrop Grumman on this remarkable accomplishment. And finally, the emerging trend of increased defense spending by Western Nations adds further momentum to our favorable outlook for Space & Defense. This includes the recent Black Hawk order by the US Army both for its own purposes and for the US foreign military sales program as well as the global demand for the F-35. Current plans with the Department of Defense to acquire over 2,400 F-35s and international demand adds hundreds more including from the eight cost sharing partner nations. Turning to Industrial. Sales declined 3.5% during the second quarter on lower wind energy sales, although much of the decrease was offset by strengthening sales in the automotive and recreation submarkets as well as consumer electronics. Our Industrials team is doing a terrific job in replacing the wind energy business with growth from other existing markets as well as identifying new markets where Hexcel can provide value-adding solutions that have the potential to be solid growth contributors over time, such as marine and select-energy applications. Year-to-date total Hexcel sales are up almost 27% year-over-year in constant currency and EPS is at $0.55 compared to a negative $0.02 this time last year, all of which reflects Hexcel's strong performance and forward momentum. Now let me turn the call over to Patrick to provide more details on the numbers.

Thank you, Nick. As a reminder, the majority of our sales is denominated in dollars. However, our cost base is a mix of Dollars, Euros and British pounds as we have a significant manufacturing presence in Europe. As a result when the dollar strengthens against the euro and the pound, our sales translate lower, while our costs also translate lower leading to a net benefit to our margins. Conversely, a weak dollar is a headwind to our financial results. We hedge this currency exposure over a 10-quarter horizon to protect our operating income. The recent strengthening of the dollar versus the euro and pound had a negative impact to our sales during the second quarter, while providing a tailwind to margins. As a reminder, the year-over-year sales comparisons, I will provide are in constant currency which thereby removes the foreign exchange impact to our sales. Turning to our three markets. Commercial Aerospace represented approximately 58% of total second quarter sales. Second quarter Commercial Aerospace sales of $227.6 million increased 49.5%, compared to the second quarter of 2021 with strong growth in narrowbodies, the A350 program and business jets. Also noteworthy is that Commercial Aerospace sales continued to grow sequentially from the first quarter of 2022 based primarily on growth in Airbus platforms. Space & Defense represented 28% of second quarter sales and totaled $111.9 million increasing 7% from the same period in 2021. Growth drivers included Space, the CH-53K heavy lift helicopter and a number of international military platforms. The growth was offset by some softening of sales to legacy rotorcraft programs, including the Black Hawk and V-22. Industrial comprised 14% of second quarter 2022 sales. Industrial sales totaled $53.5 million decreasing 3.5%, compared to the second quarter of 2021. While we experienced continued strength across a variety of markets including recreation, automotive and consumer electronics this was more than offset by lower wind energy sales. Wind energy represented just below 30% of second quarter industrial sales. On a consolidated basis, gross margin for the second quarter was 22.8% compared to 19.3% in the second quarter of 2021. The improved gross margin principally reflects operating leverage within the business, as we grow back into our capacity. The higher sales volume year-over-year and greater capacity utilization is reducing the under absorption of fixed costs, and our cost saving actions taken during the pandemic are also boosting results. We continue to manage inflationary cost pressures and global logistics challenges while at the same time minimizing delivery delays to our customers. As we have previously explained many of our largest raw material purchases are protected by long-term contracts or financial hedges that are designed to layer in pricing changes over time and minimize quarterly volatility to earnings. We continue to experience some inflationary cost impacts with certain raw materials, logistics costs, consumables such as packaging materials and higher energy costs. As a percentage of sales, selling, general and administrative expenses and R&D expenses were 11.4% in the current quarter compared to 13.3% in the second quarter of 2021. As this decreasing percentage of sales illustrates, we remain focused on cost control and improved efficiencies. So, that our sales grow at a higher rate than costs return to the business. Adjusted operating income in the second quarter was $44.7 million, or 11.4% of sales. The year-over-year impact of exchange rates in the second quarter was favorable by approximately 30 basis points. The Hexcel team is pleased to have generated a double-digit quarterly adjusted operating margin again for the first time, since the beginning of the pandemic. We are delivering consistent sustained performance in the face of a challenging environment. This includes the previously mentioned logistical and supply chain issues and inflationary pressures we are all facing, as well as managing through some near-term new employee training challenges. We will work through this, as our employees gain experience. However, it is one more headwind that our team is managing. These challenges are not an excuse, and based on the confidence we have in our ability to execute we are maintaining our 2022 guidance and continue to target double-digit adjusted operating margin for the full year of 2022. Now turning to our two segments, the Composite Materials segment represented 81% of total sales, and generated a 14.1% adjusted operating margin, strengthening on higher capacity utilization as the adjusted operating margin in the comparable prior period was 10.7%. The Engineered Products segment, which is comprised of our structures and engineered core businesses represented 19% of total sales and generated a 12% adjusted operating margin. The adjusted operating margin in the comparable prior year period was 7.6%. The effective tax rate for the second quarter of 2022 was 23% compared to 58% in the second quarter of 2021, which included a discrete tax charge of $2.7 million related to the re-measurement of the net deferred tax liability in a foreign tax jurisdiction. Net cash provided by operating activities was $18.3 million for the first six months of 2022 compared to $38.9 million for the first six months of 2021. Working capital was a cash use of $95.1 million year-to-date into 2022 increasing to support higher sales. This compares to working capital being a cash use of $19.6 million in the first half of 2021. Capital expenditures on an accrual basis were $28.3 million for the first six months of 2022 compared to $7.8 million in the prior year period. Capital expenditures are increasing this year on higher capacity utilization that increases maintenance CapEx and plus growth CapEx as we expand our production in Morocco to support Commercial Aerospace and Defense markets, as well as building our new research and technology innovation center in Salt Lake City Utah to support next-generation aircraft and future industrial applications. This state-of-the-art research and technology innovation center, replaces a much smaller R&D center we have in Dublin, California. We sold the California site in the second quarter and recognized a gain on the sale of $19.4 million. We have a short-term lease from the buyer, as we prepared to move the testing equipment to Salt Lake City. The property sale proceeds were used to pay down our revolver, however are not included in the free cash flow calculation. Free cash flow for the first six months of 2022 was negative $19.6 million, compared to a positive $29.7 million in the comparable prior year period. As we referenced last quarter, our free cash flow generation is typically weighted towards the second half of the year. Due to the macro environment with global logistics challenges previously discussed, we are holding more buffer or safety stock inventory than we would during normal times. The higher levels of inventory will help us support and protect our customers as much as possible from the prevailing supply chain stresses, facing the world today. We expect this situation to persist for at least the remainder of 2022. Depending on the timing and severity of the logistics issues persisting, we may experience some headwinds to free cash flow generation, as inventory uses more cash than previously expected. We are now operating under the original revolver terms and conditions for the 2019 agreement with the exception of the facility limit, which is now $750 million. Our leverage, as measured by gross debt to trailing 12-month adjusted EBITDA, must be at or below 3.7 times measured at each quarter end. As of June 30, 2022, our leverage was comfortably below this level. We did not repurchase any common stock during the second quarter of 2022. The remaining authorization under the share repurchase program at June 30 was $217 million. The Board of Directors declared a $0.10 quarterly dividend yesterday, payable to stockholders of record as of August 5, with a payment date of August 12. With that, let me turn the call back to Nick.

Thanks, Patrick. We are encouraged to see passenger air travel nearing pre-pandemic levels in many parts of the world and the pull from our customers for lightweight, strong durable advanced composites continues to grow. Throughout the remainder of 2022, Hexcel will stay focused on efficiency and productivity, cash management and overall performance, especially in quality and on-time delivery. We recognize the stresses and strengths on the supply chain and labor market. Amid the uncertainty, we must remain vigilant as we move forward. We are also keenly aware, that macroeconomic factors such as crude oil prices are causing inflationary pressures, not only for suppliers, but also for the underlying industry as a whole. At the same time, we also know that those pressures incentivize airlines to look for solutions to mitigate those costs and that means a greater pull for new aircraft made from lighter-weight composites that not only run more efficiently, but also help meet sustainability objectives. Our commitment to transparency and collaboration with our customers is a key differentiator for Hexcel. Our team is in constant contact with our key suppliers and customers, to ensure that we are aligned with raw material availability and customer demand for finished products. We will always continue our focus on next-generation products, heavyweight innovation for lightweight solutions. In fact, a couple of weeks ago, we announced that Hexcel is joined with Spirit AeroSystems Europe at its Aerospace Innovation Center in Scotland to develop more sustainable aircraft manufacturing technologies for future aircraft production, including composite manufacturing processes, designed for high-volume production of next-generation aircraft. Our message from earlier this year remains unchanged. Our fundamentals remain strong, and our team is focused on driving through all the challenges to take full advantage of the significant growth that lies ahead, to ensure that we deliver strong shareholder value. Brent, we'll now turn it over to you and take questions.

[Operator Instructions]Your first question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is open.

Hey good morning guys and thank you for the time. Nice quarter. Maybe if we could think about margins and I know Patrick you don't guide to profitability, but you had pretty strong margins in the quarter. How do we think about them trending in the second half and as we exit the year? And as companies talk about costs and supply chain headwinds, you've previously spoken about $150 million in cost takeout. How much of that do you think is permanent now as we go forward?

Yes. Hi Sheila. So, in terms of margins I mean I think and let me say it again in those comments, we're still aiming for double-digit adjusted operating margin for the full 2022 year and you can kind of back into that. Obviously, you've seen Q1 and Q2 now and the year-to-date position which is just under double-digits. So, we're looking to sort of another couple of strong solid quarters to close out. You're absolutely right. We've got the inflationary pressures, we've got the supply chain challenges, we're working very hard to mitigate that. They are real and our team as you can imagine is working very hard, but we're standing by that double-digit target. In terms of the $150 million cost takeout, I think as we've said all along as the business grows back and we're sort of adding hundreds of millions to the topline, the overhead cost will grow back. Now, our objective is to hold on to as much of that if you like long-term as possible to overcome the sort of depreciation headwind essentially compared to when we were at this level of revenue historically. A large chunk of it will come back, but we're going to work as hard as we can to minimize that and hold on to as large a portion as possible. I'm not going to call out a specific number, but that's definitely our objective to hold on to that sort of margin leverage opportunity that we did see in Q2.

Okay, great. Thank you.

Your next question is from the line of David Strauss with Barclays. Your line is open.

Good morning. Thank you.

Good morning David.

Hey Nick. So, your revenue guidance for the full year looks like it's implying relatively flat in the second half. Is that currency, or I would assume Commercial Aero gets a little bit better sequentially as we go from here and maybe Defense and Industrial relatively flat. So, can you just talk about second half versus first half on the revenue side?

So, David I'll -- I guess I'll answer it this way in that. Clearly we've had a wide range on both our topline and our EPS and perhaps a little bit of conservatism and caution built in there simply because of what we're seeing with uncertainties in the supply chain and the inflationary pressures and the energy issues. Clearly, based on what we see today, our demand is higher than what the midpoint of our guidance is indicating. So, provided we're able to overcome the challenges that are in front of us we certainly would expect and hope to have the opportunity to deliver beyond the midpoint.

Okay. Thanks. And on currency Patrick I know you commented about hedging out kind of two, two and a half years in the future. But we've seen a pretty significant strengthening here in the dollar which should be a tailwind for you guys from a margin and EPS standpoint. Can you just talk about what that impact would look like as we move out over the next year or two?

Yes sure. So as you absolutely correctly recognized we hedge over 10 quarters. We layer in further hedges quarter-by-quarter. We follow a strict sort of guideline and process. In 2022, I mean a lot coming into the year a large portion of our exposure was already hedged. And so the benefit of the what I would call very strong dollar today is marginal. And I think you saw it was about 30 basis points in the quarter. That tailwind will continue through the year. And what we're doing obviously is now locking in strong dollar rates for 2023 and into 2024. And so we're kind of giving ourselves that strong, but it's really a smoothing in benefit over time as we look out. So we will get that benefit spread out overtime, it's going to help us. You're not going to see some dramatic boost in margins. I just don't want anyone to have that expectation really is a result of our smoothing policy. So we're in a good position, a strong dollar is definitely a tailwind and we're going to benefit over the coming quarters.

Great. Thanks very much.

Your next question is from the line of Ron Epstein with Bank of America. Your line is open.

Yeah. Hi. Good morning guys. Maybe just a bigger picture question, when you think about the growth of the business with a new airplane from Boeing looking like it's going to get pushed out maybe indefinitely. Where are you looking for growth in other areas? I mean, you mentioned in your prepared remarks and you won work in Commercial Space. I mean how big, do you see that getting for you. I mean, ultimately, where do you see that your Defense business could go to drive growth?

So with respect to growth opportunities less a new airplane we always have areas where we're working with our customers on converting metal parts. Given the new technologies that are evolving -- given the new efficiencies that are, evolving to continue to drive performance improvements as well as to push the envelope on development when that new aircraft does come along. So Commercial Aerospace clearly there's a lot of work going on to prepare for that next new airplane, assuming it will require advanced composites more producible composites and a wider portion of the aircraft will be composite at the end of the day. And there's a lot of work going on today with virtually all of our customers to get in that position and develop those materials so that they're production-ready. On the Space & Defense that's an area where we see exciting growth. And we're even to the point of looking at our organization and considering some modifications to basically be more focused in various areas that perhaps we didn't really concentrate on in years past. So the new technology on the various platforms whether they're unmanned or manned, or electric, or advanced helicopters with FARA and FLRAA we're working all those. And continue to be optimistic based on what we see and what we hope to see on budgets and Western spending increases.

Got it, got it. And then if you can disclose this, I mean, what's the contribution on an A321 for you guys when we think about where that program could go, or maybe more broadly how meaningful is it for the company?

Well, it's the shipset content is $200,000 to $500,000. And obviously Airbus backlog, if my memory is correct is around 6,000 aircraft. Clearly Airbus, are ramping up as we speak with a target to get to 65 by mid-2023 and the supply chain is looking at going up to as high as 75 in the out years. So if you do the math on that kind of shipset content type times those types of volumes it is very meaningful for Hexcel as is the 737 MAX as it grows back up into a prior production level which we expect to do in the out years as well.

Got you. And then maybe one last one if I can, what's your sense on when we could see 787 back at double-digit production rate?

Well I don't have a crystal ball, but after spending a week at Farnborough, I would just say that talking to various peers and the supply chain it seems like there's a lot of energy and momentum and hope that it's going to be sooner rather than later. I'll leave it to Boeing to potentially elaborate on that when they report tomorrow.

Yes. All right. Thanks, guys.

You’re welcome. Brent do we have another question?

Your next question is from the line of Michael Ciarmoli with Truist Securities. Your line is open.

Hey, guys. Good morning. Thanks for taking the question. Nice results. Just within the Engineered Products segment the margins there are dipping sequentially and I know you're not going to guide towards the remainder of the year but any sort of color you can give us on sort of the margin step down in the quarter there sequentially? And I guess the same for the Space & Defense revenues, I think you may have called out Black Hawk and V-22. Just wondering if that was the driver for the sequential declines in revenue there?

Yes. So if I start with Engineered Products. I mean I think – I mean I said it before and I have no doubt in the future update again. I mean Engineered Products is a bit lumpy. It's kind of program-specific we get tooling from time to time coming through. Q1 was particularly strong, I would state that. I mean Q2 to be honest is in the normal range. I mean I think historically, we kind of said 12% to 14% for Engineered Products. We're at the bottom end of that range but we're kind of there or thereabout. So it is lumpy. I mean as with Space & Defense similarly, I mean Space especially can be lumpy with sort of bulk quarters quarter-to-quarter coming and going and Defense itself some programs up, down and the supply chain is still playing with a bit of inventory here and there. Year-over-year I think we were 7% up in constant currency. So that's kind of in line with our guidance essentially for the year. And honestly, I wouldn't get too hung up on the sequentiality of one quarter over another.

Got it. And just last one maybe to what Ron was asking. Where are you guys on the 787 right now? Is that line totally idled, or do you have any sort of expectations, or I know you said you're going to wait on Boeing tomorrow. But any contributions at all right now from the 787?

Well, we're at a very low rate aligned with Boeing. So our shipping stays fluid, they're running their line. I think the expectation is as soon as they get clearance from the FAA, they probably will follow with a fairly quick announcement on their ramp increase going up to as high as five in the foreseeable future. So I could just say it's a very low production on Hexcel's part today, pretty much aligned with what Boeing are running off their production line.

Got it. Thanks, guys.

Thanks, Michael.

Your next question is from the line of John McNulty with BMO Capital Markets. Your line is open.

Yes. Thanks for taking my question. So I guess the first one would just be with regard to some of the inflationary pressures that you're seeing, what are the levers that you have to offset them? Do you have any on the revenue front, or is it all going to be internal kind of self-help related drivers? Like how should we be thinking about that?

Yes. Hi. John. I mean we'll, obviously help ourselves as much as we can if I can start there. I mean we have these good long-term contracts for some of our input costs like key raw materials we're always working on continuous improvement and efficiency to overcome inflationary cost pressures. We do have some sort of levers on pricing. Our industrial space, we were already passing through in many instances and that rolls through and that helped. In Aerospace there's more of a lag. Some of our contracts are difficult to move on. But there are many others that have annual sort of check points if you like and review points with which we will push as much as we can as we go into 2023. So we have some pricing ability in Aerospace. It's not zero. Not as flexible as Industrial where we're pushing hard. So we're working on both sides of the equation, helping ourselves as you put it as much as we possibly can and it's in our control. And we will push the pricing levers where we have the opportunity.

Got it. That's helpful. And then I guess just a second question. You have a big European footprint and luckily I guess not really any exposure or much exposure on the Germany side. But I guess, with concerns about Germany being cut off on the gas front, some issues around potential constraints there. Do you -- can you speak of the raw material risk that you might have, with raws maybe coming from that region? And how you might be, kind of setting yourself up to avoid any issues that might pop up, as we get into the back half of the year if the spigots, do get shut off?

Yes, John. So we do have a site in Stade, Germany that supports our customers and Airbus being one of the primary ones there. And we're monitoring, what we're currently doing with respect to raw materials and energy in that area and even some conversion options that we can look at, if we have to. I'd say, the big benefit we have is that again remember our assets are fungible. They're very flexible. And if something happened in the short term to impact Germany, we could reallocate that production to other sites. And we basically, wouldn't miss a beat on that. With respect to the broader impact on indirect and chemicals, and Germany has a pretty good presence of large chemical companies. And if they're forced, to limit their output and/or limit their uptime that could ripple through the industry. And again, I can't predict what the impact would be, I could just tell you something, I hope we don't have to deal with.

Got it. Fair enough. Thanks for the color.

Thank you, John.

Your next question is from Pete Skibitski with Alembic Global. Your line is open.

Hi, good morning, guys.

Good morning.

Hi, guys, the updated kind of production outlook for the F-35 kind of flat rate for the next few years, before expected to ramp again. Should we think that that matches the revenue outlook for you guys there, or are there some spares that would be additive for you guys, or related revenues for F-35?

Fundamentally, we will track the 155 156 sort of outlook rate there or thereabouts so a little bit of noise plus or minus sort of single digits with inventory sort of plays and pushouts or pull-ins occasionally. But I think, the -- in terms of spare parts and extra things like that, we have a little bit of aftermarket with our Amesbury business for the F-35. But fundamentally, we're going to track the headline there right.

Okay. Appreciate it. Thank you

Your next question is from the line of Robert Spingarn with Melius Research. Your line is open.

Hi, good morning.

Good morning, Robert.

Nick you talked about content upside across the portfolio, constantly looking for things you can do. And I wanted to ask you specifically about Wing of Tomorrow for the A320, Spirits recently commented that they produced a 51-foot long composite skin out-of-autoclave that could be used there, and it could be ready in two to three years. So I wanted to see, what type of work you might be doing on the Wing of Tomorrow? And in general, what your -- a lot of these programs are talking about rewinging with composites. So how much of an opportunity is wings, all by itself?

So, we're excited to see that the first demonstrator full scale was built. We've been working with Airbus, for a long time on smaller scale, ramp up various technologies. But in the wing, there are several different technologies being worked at the same time in parallel, because I think Airbus and the aircraft manufacturers they want to keep the flexibility to go where the technology will afford them the best processing, the best layout and the overall best economic solution based on, when that new wing is launched. So, infusion technology out-of-autoclave technology, high rate laydown technology, different fiber technology and resin technology. Those are all being used and tested and proven in the Airbus, Wing of Tomorrow demonstrator. So the demonstrator that was just -- it's just one phase of many programs that are ongoing in various countries, to support that advanced technology. And I can tell you, we are very closely aligned with Airbus in their pursuits and with our other customers, on how they're preparing for the next new program platform whether it's a narrowbody or a new business jet or a new rotorcraft.

Okay. And then just quickly Patrick for you. On the back of that, that would be organic content growth inorganic via M&A. As the balance sheet improves here and the environment the end markets get better, how do you think about capital deployment? Do you look more toward M&A now with some valuations out there under pressure or more on the share repo side?

Well, it's going to be a balance. So, I think as we come out of the year and go into next year, we've already flagged. We are going to start to generate cash, our CapEx levels will remain subdued sort of under $100 million or so for the forthcoming years. And that's going to leave us in a position to exactly do that. Think about some share repurchase, which I imagine we will do some. But absolutely, we will be looking at M&A. And if we see in our disciplined way sort of as you say value propositions that meet our criteria of value-add sustaining technology that Hexcel can bring something to, we're definitely, definitely on our agenda. So inorganic growth, I do expect to be part of the coming year sort of process, along with some share buyback. It's not a 100% one or 100% the other there will be a balance, but it will include M&A.

And would M&A, Nick, this might be for you would M&A be vertical or horizontal how – where can you add?

Well, I don't – I think our lens is pretty open as we demonstrated back in 2019, 2020 with the Woodward direction we were moving. So I can tell you, our business development team, are looking adjacent upstream downstream as well as what products can enhance our total offering to our customers through value proposition and advancing composite penetration, or material penetration.

Okay. Thank you, both.

Thank you.

Your next question is from Richard Safran with Seaport Research Partners. Your line is open.

Nick, Patrick, Kurt, good morning. How are you?

Good morning.

Good morning.

I want to ask you about mix. And if you've already mentioned this and talked about it and I missed it I apologize. Now correct me, if I'm wrong, but the quarter-over-quarter improvement in the intersegment indicates mix was a bit better. I know that sometimes mix can be effective by different things, but I thought you might discuss, how mix trends from here? Is this just simply a case with higher volume should we be expecting more of your higher-margin products?

Yeah. I mean, mix is a part of it. I mean, the biggest step-up we're seeing is volume leverage right now. So as we bring through the sales, we bring through more sort of variable margin, and we tend to have a fairly strong variable margin overall, as we're bringing that through against the overhead cost base and we've talked about the cost savings that we've put in place. Yeah, that's really what's driving the incremental margins and the bottom line margin step up. Mix has I guess has some play is probably going to be slightly less pronounced. I think we talked quite a lot about mix in 2021. We had a lot of fiber coming through, and that helped us in the early days really get quite a sort of strong acceleration. I think our overall margins at the variable level are probably going to steady off. I mean, wind sales coming down. We've talked about that was probably one of our lower-margin businesses. So as we grow some of the perhaps more value-add industrial sales, we may get a marginal benefit there. Obviously industrial is only sort of 13%, 14% of our sales, but it all helps. So I wouldn't overplay the mix. I think as we pull through Hexcel carbon fiber and we're putting a lot through today. And if that increases that is the best sort of mixed pattern we can have. But I think we're getting to sort of a steady-state mix now, and it's really top line growth that's going to continue to give us the leverage over the overhead to drive double-digit margins this year and then increase as we go forward.

Okay. And then just one more, if you would comment further. Nick, you mentioned a tight labor market. So I wanted to ask you about employment, and expect – employment levels and expectations there. How much do you expect to grow the workforce? How you're progressing towards that goal? And I'm kind of curious if you could comment on if you think that labor cost inflation is starting to become an issue?

So, I would say, it's mix. It depends on the site, the location. We see a few tight areas, I can say, in the UK where attracting, recruiting and hiring labor has been a little more challenging than some of the other areas we have. But I would say, we're being successful and we brought in the team that we need to deliver to the demand today. Obviously, as we continue to grow and ramp up our assets, we're going to be hiring pretty aggressively for the next 12 months. I would say that one of the bigger impacts on the learning curve we're going through is with respect to training of new employees and getting their output and efficiency up to the level where we were pre-pandemic, and we're on that journey. We're on that path. We have history that gives us confidence on how that growth and that improvement will happen as volume increases an over time. So, labor is currently an area we've had to redefine how we go out attract and recruit labor, but we've been very successful, and I attribute that to Hexcel's future, our products, our culture, the drive towards sustainability and innovation, all of which are attractive to new talent in the marketplace. With respect to labor inflation, clearly it was higher this year than it had been historically. And based on what I'm seeing right now, I anticipate it's going to be higher next year. But to zero in on how much, that's an unknown and we just continue to monitor our competitiveness. We'll make adjustments real time as required, and we'll see what the data shows us as we get ready for 2023 planning.

Thank you very much.

Thank you.

Your next question is from the line of Paretosh Misra with Berenberg. Your line is open.

Thanks and good morning. I was just curious about your consumer electronics business. I know it's not a big part of your portfolio, but what exactly are you making? Because many of the electronics companies are seeing a slowdown, so just wondering what's driving growth for Hexcel?

Yeah. Hi, Paretosh. It's really been carbon fiber, quite honestly, and directing some of our carbon fiber into what has been a decent market sort of coming out of the pandemic, sort of laptops adopting carbon fiber, some of the sort of circuit boards where they want strength and lightweight stiffness. So, there's been quite a lot of success directing material there. So, I think the demand has been strong for some of these consumer electronics. We will see going forward. But certainly to-date, it's been a good business for us.

Thanks, interesting. And Patrick, if I could ask just one more. You might have covered that earlier but in your second half guidance, are you assuming any restocking related to A350 or not so much?

Yes. I mean, I guess our second hand -- sorry, our second half guidance to be clear is sort of by default. But, in terms of restocking, it's going to be a gradual process across all the programs. I mean whether it's the A350 or the A320 family or now the MAX and hopefully the 787. The destocking is abrupt. It's very quickly. It comes down. The restocking will take place over a number of years. So as the 350 if we talk to that specifically moves from five to six at some point early next year and then hopefully up to seven, and we're going to see the freight to come on, yes, they will definitely be restocking in those specific program supply chains, but it's going to be a gradual process. And I wouldn't say there's anything specific built into the second half of this year.

Got it. Understood. Thank you.

Your next question is from Ken Herbert with RBC. Your line is open.

Good morning, Nick and Patrick.

Good morning, Ken.

I guess, Patrick, I wanted to ask on working capital. The last couple of quarters you've invested about $100 million it looks like. I think you called that out in your comments. What do you need to see aside from just working capital build to support rate increase? What do you need to see on supply chain or other factors to maybe feel comfortable that you can lower this a little bit? And is there a point here in the second half of this year when maybe it becomes a source of cash?

Yes. I think in the current environment, Ken, to be honest, I think, we're really looking at 2023 before the world dramatically improves. I mean, I'm talking about shipping delays, shipping constraints ramp-up pressures on lots of sort of the chemical guys who feed into the raw materials we buy. And so our sourcing team are working day in, day out to get the raw material and it's a battle that, I don't know that any of us have seen anything like this. I mean, credit to the team have been hugely successful thus far and that's our objective clearly to maintain that going forward. But part of it is just to be a little bit cautious to hold on to this buffer safe the inventory, and I think that's going to persist. I think I said in my comments through the end of this year I think it will be into 2023. Hopefully, we see some improvement. We get some confidence, but we want to do the very best for our customers. And if we have to hold a little bit of working capital to do that, that's what we're going to do.

Okay. That's helpful. And if I could on the business jet outlook strong growth there. Can you talk about the opportunity to maybe replicate what you've done obviously on the Falcon 10X on other programs perhaps or with other customers? And at what point does that growth start to moderate either second half of this year or at some point in next year as you anniversary the more challenging comps?

So, business jets, the nice thing about business jets are, there are a lot of different platforms and the volumes tend to be a little lower content are going up. So there's not a specific program that really drives that segment. It's a combination of the entire market set. Clearly, Gulfstream has been pushing the envelope with respect to composite penetration and we have very strong content on the new wide business jets, the G650 and strong content on the G600 and the G500. We also have great positions on the Embraer 190, the Falcon, the challenger the list goes on and on. If you look quarter-over-quarter virtually every platform grew from last year's level and that's based on backlogs, it's based on tight inventory and it's based on flight hours continuing to go up. So, clearly, lightweight materials make airplanes more efficient. It doesn't matter, if it's a widebody or narrowbody or a business jet. And it's just a matter of time, until more and more penetration takes place into the primary structures, as it did on the Falcon 10X. So, I'm excited. We have teams actually meeting with our customers today in Salt Lake City, on bizjet strategy, and it's a great growth opportunity and we have a great position with our customers there.

Great. Thanks, Nick

Your final question comes from the line of Mike Sison with Wells Fargo. Your line is open.

Well, Mike. Okay. Brent, if we could just go to one more and it's just one final question only please.

Certainly, your next question, final question comes from Gautam Khanna with Cowen. Your line is open.

If there's any program – Hi, guys. I was wondering if there's any program -- it sounded like the 787, but where you guys are misaligned either there's destocking or you're misaligned with underlying assembly rates at Airbus or Boeing? And if so, which one?

I think we do a very good job of understanding, what inventories are being held by our customers, what they're running off their production lines. We know our shipset content and we triangulate to make sure that from a top line, from a high level from a public disclosure that we're aligned. And again it's -- as Patrick said on the destocking side, it was very abrupt. It was very significant. Today, given that we've been at lower rates on most of the platforms for a period of time, the supply chain has stabilized. I think we're very aligned virtually with all programs that we're tracking and that we have visibility to. So, I don't see any misalignment that's material in our supply chain. Now I would, have to remind everybody that some of our supply chains have 40 or 50 ship to locations. So, to think that every single supplier in that supply chain is going to be at the exact same build rate, the exact same level of inventory in days, that would be a poor assumption. And that's not how it works. And that's why, we see some lumpiness even in the Commercial Aerospace around the supply chain and our various ship to locations and customers.

Ladies and gentlemen thank you for your participation. This concludes today's conference call. You may now disconnect.