Hexcel Corp /De/ Q2 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Hexcel Q2 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your first speaker today, Mr. Patrick Winterlich, Chief Financial Officer. Thank you. Please go ahead, sir.

Thank you. Good morning, everyone. Welcome to Hexcel Corporation’s second quarter 2021 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 2021 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 results and look ahead to the second half of the year. The global COVID pandemic is far from over, but with the growing availability of vaccinations, there is cautious yet positive momentum as domestic travel appears to be on the rebound and aircraft backlogs have started to grow again. While there remains uncertainty ahead, our focus has shifted toward a return to growth. All of us recognize that the past year and a half has been unprecedented. The global pandemic required Hexcel to take aggressive and swift restructuring actions, which we did. We also took advantage of the lower production levels to drive costs and efficiency improvements. These efforts have positioned us to exit the pandemic more focused and more efficient for a strong rebound. The way our team responded to the challenges has been phenomenal and is reflected in the results we reported in our news release last night. Our robust start to the year continued into the second quarter with results in line with or slightly ahead of our expectations. We achieved strong margin performance, despite lower year-over-year sales, as a result of a favorable margin mix from higher carbon fiber sales. Combined with efficiency improvements and reductions in our overhead costs, we were able to deliver $0.08 of adjusted EPS for the quarter. If you remember back to the second quarter of 2020, we also reported $0.08 of adjusted EPS; however, on sales that were almost 17% higher in constant currency. This demonstrates the cost control actions that we took quickly in 2020 and that continue today are making a significant difference in the sustained value we offer to our shareholders. As we anticipated last quarter, we believe inventory destocking is largely behind us as we move into the second half of the year. Specifically, destocking for the A320 and 737 MAX are basically complete. The widebody still has some inventory to burn through, and we expect that will take a few more months to align with announced build rates. We are encouraged that airlines such as United are placing orders with the commercial aerospace OEMs as revenue passenger kilometers continue to grow around the world. Deliveries climbed in June for both Airbus and Boeing, which we believe is further evidence that we along with our customers are beginning to emerge from the effects of this pandemic-driven downturn. However, while we anticipate gradual increases in build rates in the coming months, we recognize that it will take some time for rates to return to 2019 levels. Even with vaccines restoring confidence in travel, there are uncertainties with additional variants of the COVID-19 virus spreading. U.S. air travel is steadily increasing, but still about 25% lower than before the pandemic. European travel is improving; however, the recovery is slower, with flights remaining about 50% lower than pre-pandemic levels. So, while we see some encouraging signs and are planning for increased demand and a gradual recovery, we recognize that the effects of the pandemic on commercial aerospace and our business are likely to remain for some time. Even so, we’re very excited about the future and pride ourselves on a relentless drive for continuous improvement. With that in mind, we have taken full advantage of this time to deepen our customer relationships, which have never been stronger, to further improve our processes, and to build our broad portfolio and our commitment to continued innovation. We announced in May that we’re building a flagship center of excellence for research and technology in the U.S. to support next-generation developments in advanced composite technologies. When it opens in 2022 at our Salt Lake City campus, it will be our largest center for innovation and product development in North America and a showcase for our advanced composites technologies. Eventually, about 150 scientists and other employees will work at the new center, including many of the experienced and talented R&T employees currently working in Dublin, California. We will eventually sell the property in California with the proceeds expected to fund a significant portion of our construction costs for the new center. With about 100,000 square feet of laboratory and office space and the latest state-of-the-art testing equipment, it will allow us to expand our research, to further develop new products and processes, and provide an even greater opportunity for us to collaborate with our customers on the latest and advanced composites technology to deliver innovative solutions and support future growth. Design efforts are well underway, and we expect to break ground in the fourth quarter of this year. We’re excited to make this investment in innovation today to ensure our continued leadership tomorrow. I look forward to inviting many of you to visit once the site opens toward the end of next year. I recently completed touring all of our U.S. locations to conduct site readiness reviews. What I found during these site visits thrilled me. Our workforce is engaged, focused, and highly motivated for a return to growth. The caliber of site leadership and the shop floor teams across our plants is truly outstanding. I was shown numerous examples of increased productivity, significant process enhancements and a long list of continuous improvement projects our team has implemented across our manufacturing footprint during the pandemic to reduce costs, further enhance worker safety and job quality, and to position Hexcel to expand margins as growth returns. The ability of the supply chain to ramp up remains a watch item for us, and we’re working very closely with our suppliers to successfully overcome any challenges that arise. The same focus applies to our labor requirements, which I’m happy to say are growing once again. At this point, we have been able to attract the labor we need; yet, we anticipate further challenges, which we will address through robust recruitment, planning and continuing to stay in lockstep with our customers. Now, let me highlight some of the results from the quarter. Aerospace sales of $154 million were down almost 25%, compared to the second quarter of last year. Narrowbody demand is recovering quickly with second quarter sales reaching their highest level since the first quarter of 2020. Sales to other commercial aerospace, such as regional and business aircraft, were down 27% compared to 2020. Business jets comprise the largest portion of this sector and sales continued to recover but remained lower year-over-year. Space and defense sales were about $107 million, which represents relatively flat year-over-year performance, affected primarily by pandemic-related production delays. As you know, we have significant content on both the Lockheed Martin F-35 and Sikorsky CH-53K, with these platforms receiving new orders within the past month. Both will continue to be strong programs for us, as well as the 100-plus other defense and space programs in this sector. Industrial sales were about $60 million during the quarter, which was a 15% decline in constant currency. Wind energy sales, which is the largest submarket in industrial, declined 44%, which reflects ongoing softer demand, along with the previously reported closure of our wind-blade prepreg production facility in North America last November. In addition, solid sales in other industrial markets, including automotive and recreation, helped offset reduced wind energy sales during the quarter. Throughout the pandemic, we have maintained a strong focus on cash. In the first half, our free cash flow was almost $30 million, compared to just over $33 million for the first six months of 2020. Before I turn the call over to Patrick, I want to provide a brief update on our activities related to sustainability. Sustainability is at the heart of Hexcel, innovating and producing modern lightweight advanced composite materials, enabling the evolution of more aerodynamic, fuel-efficient aircraft, producing significantly lower emissions than older generation aircraft. More broadly, responsibility has been one of our four primary values for many years, and it calls on us to strive to be good citizens in the communities in which we live and work. We continue to build on our sustainability goals, highlighted in our sustainability report first published several years ago. And we are now excited to participate in the Carbon Disclosure Project or CDP. Initially, the CDP report will be submitted selectively for some of our customers this year, and we expect to share next year’s submittal publicly. We recognize that many of our investors evaluate our progress in relation to sustainability and especially our ongoing work to reduce greenhouse gas emissions. And you can be assured of our continued strong focus and actions on this topic. Now, I’ll turn it over to Patrick to provide more details on the numbers.

Thank you, Nick. As a reminder, the year-over-year comparisons are in constant currency. 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. Quarterly sales totaled $320.3 million. The sales decrease year-over-year reflects production rate decreases by our commercial aerospace customers in response to the pandemic combined with the continued supply chain destocking. You will recall that in the second quarter of 2020, OEM production rates were only beginning to be reduced midway through the quarter, and that supply chain destocking had not yet begun to any great degree. I say this as a reminder to consider when evaluating the year-over-year sales comparisons. Turning to our three markets. Commercial aerospace represented approximately 48% of total second quarter sales. Second quarter commercial aerospace sales of $153.7 million decreased 24.8% compared to the second quarter of 2020 as destocking continued. We believe the substantial destocking is now behind us as we enter the third quarter of 2021 and that our narrowbody production is generally aligned with OEM production rates. However, our widebody sales are still facing some lingering supply chain adjustments that are expected to conclude by the end of the summer. Space and defense represented 33% of second quarter sales and totaled $106.9 million, decreasing 2.7% from the same period in 2020. While the demand outlook remains favorable for composite secular growth to enhance performance and extend capabilities, quarter-to-quarter sales can fluctuate, as we experienced in the second quarter. Lockheed Martin has publicly commented that F-35 deliveries in 2021 will be lower than initial expectations on pandemic-induced disruptions, which impacts the supply chain and our deliveries. Sales were also softer due to some short-term pandemic-related interruptions impacting other programs, including a number of space-oriented platforms with customers located outside of the United States. Industrial comprised 19% of second quarter 2021 sales. Industrial sales totaled $59.7 million, decreasing 15.1% compared to the second quarter of 2020. Wind demand remained subdued while other industrial markets, including automotive and recreation, witnessed growth in the second quarter of 2020. Wind energy represented approximately 45% of second quarter industrial sales. On a consolidated basis, gross margin for the second quarter was 19.3% compared to 14.5% in the second quarter of 2020. The strengthening gross margin benefited in the quarter from a higher mix of carbon fiber sales and production. Our margin recovery will not be a completely smooth quarterly progression, though, as it will be impacted at times by step-ups in the utilization of major assets such as precursor and carbon fiber lines. Second quarter selling, general, and administrative expenses increased 24.3% or $7 million in constant currency year-over-year. Research and technology expenses decreased 3.2% in constant currency. The other expense category consisted primarily of restructuring costs in Europe. In terms of the year-over-year comparison of SG&A expenses, the second quarter of 2020 was artificially low as pandemic-induced restructuring actions led to nonrecurring reductions in stock compensation accruals as well as a temporary implementation of salary reductions. As a point of reference, second quarter 2021 SG&A expenses are lower by approximately 21% or $8.4 million compared to the pre-pandemic second quarter of 2019. Our targeted $150 million of annualized overhead cost savings has been fundamentally achieved at the end of the second quarter. As we now pivot to increasing sales and production levels, our focus will be to drive efficiencies and minimize the amount of cost that return while at the same time preparing for significant growth. Adjusted operating income in the second quarter was $19.3 million, reflecting strong variable margin performance and robust overhead cost control. The year-over-year impact of exchange rates was favorable by approximately 70 basis points. Now, turning to our two segments. The composite materials segment represented 75% of total sales and generated a 9.6% operating margin compared to 6.3% in the prior year period. Adjusting for nonrecurring costs, the adjusted composite materials operating margin in the current period was 10.7% compared to 8.9% in Q2 2020. The engineered products segment, which is comprised of our structures and engineered core businesses, represented 25% of total sales and generated a 7.4% operating income margin or 7.6% adjusted operating margin compared to 2.6% adjusted operating margin in the second quarter of 2020. The adjusted effective tax rate for the second quarter of 2021 was 18.8%. The pandemic and consequent mix of results across the countries in which we operate is expected to continue to impact the Company’s overall effective tax rate throughout 2021. Net cash generated by operating activities was $38.9 million year-to-date. Working capital was a use of $19.6 million year-to-date, primarily related due to increased receivables. Capital expenditures on an accrual basis were $3.8 million in the second quarter of 2021 compared to $11.5 million for the prior year period in 2020. Capital expenditures continue to be tightly managed with a focus on improving existing asset efficiency and new technology flexibility. Free cash flow for the second quarter of 2021 was $35.8 million compared to $51.8 million in the prior year period. Continued tight cost control and lower capital expenditures are supporting free cash flow generation. Liquidity at the end of the second quarter of 2021 consisted of $115 million of cash and an undrawn revolver balance of $543 million. Our liquidity remains well above the bank covenant minimum of $250 million, and we have no near-term debt maturities. Our revolver matures in 2024, and our two senior notes mature in 2025 and 2027, respectively. Our share repurchase program is restricted through March 31, 2022, by the revolver amendment executed in January 2021. Dividends also remain suspended at the current time. Our Board continues to regularly evaluate capital allocation priorities. As our earnings release states, we are not providing financial guidance at this time. However, I would like to reinforce and expand upon the financial outlook shared during the first quarter 2021 earnings call. We continue to expect 2021 annual sales to be lower than 2020 and below the current market consensus due to recent commercial aerospace production rate adjustments. The remainder of our previously stated expectations remain largely unchanged, including some additional restructuring costs anticipated in the remaining quarters of 2021 and are expected to be below first and second quarter levels; we continue to expect the fiscal year 2021 adjusted operating margin percentage to be in the low single digits; capital expenditure in 2021 will continue to be managed closely and are expected for the full year to be at a similar level to 2020; we expect to generate positive free cash flow in 2021 and further reduce debt levels; we expect the effective tax rate to be approximately 25% in 2021. Lastly, repeating some broad context from the first quarter’s earnings call in April, we continue to target strong mid-teens-plus operating margins once we achieve sales in the range of $1.8 billion to $1.9 billion. We are targeting to exceed prior peak margins when we return to previous peak sales levels.

Thanks, Patrick. We believe the worst is behind us, and we are cautiously optimistic about a continued and steady recovery during the remainder of 2021 that will propel us into 2022, when we expect a significant return to growth, which will extend into 2023 and beyond. Without a doubt, some of this growth will come from pent-up demand for air travel, yet much of it also comes from airlines ready to replace older, less efficient aircraft with more aerodynamic and fuel-efficient solutions as the world demands long-term reductions in greenhouse gas emissions. No company has a broader or more vertically integrated portfolio of strong, durable, and lightweight advanced composite solutions that lead to fewer emissions than Hexcel. The market is demanding lighter, yet high-performing materials, and we anticipate strong pull for our entire portfolio from carbon fiber to prepreg to engineered core for many years to come. Additionally, no team is better prepared to meet a quick ramp-up than our Hexcel team. Over the past several months, while demand retracted, we planned for the inevitable rebound. We have become more efficient, more cost-effective, and more competitive than ever. Throughout the downturn, we have improved our processes to ensure that we continue making gains, especially in employee safety, quality, and on-time delivery. Certainly, there are risks ahead and especially so within the supply chain and the availability of raw materials and labor. It comes down to staying focused and aligned with our customers, and we intend to do just that. I’m excited about the path ahead. Thanks to our great team and our commitment to innovation and continuous improvement through operational excellence, we are poised to drive strong incremental profits, generate robust cash flow, and deliver increasing returns to our shareholders. Katrina, we’ll now turn it over to you for questions.

Thank you, sir. Our first question is from Robert Spingarn from Credit Suisse. Your line is open.

Good morning. This is sort of a two-sided question related to margins. But Patrick, I guess your implied second half margin’s a little bit lower than the first half. And does that have to do with your comments just now on sales, or are there some other things at work here? I wanted to factor in inflation here on raw materials and see if you could talk a little bit about that as well, if you’re covered through hedges, not only through the end of this year but into next year as well.

Yes. Hi, Robert. To clarify, quarter two was strong, and I wouldn’t necessarily say that the second half of the year will be lower than the first half, which was at 3.4%. The strength in the second quarter was due to the product mix and a strong variable margin from the carbon fiber mix. When you combine that with the efficiencies we've discussed and the ongoing cost savings, those benefits will still apply in the second half of the year, although we may not always experience the same favorable mix. I hope that provides some context. Regarding inflationary pressures, they are clearly present today. However, the Hexcel team is effectively managing this with our long-term back-to-back purchase contracts that have fixed pricing. Therefore, a lot of our key resins will remain stable in price. For example, acrylonitrile, which is the primary raw material for our carbon fiber, is hedged. While this won't completely prevent price increases, it will help stabilize them and protect us from significant impacts this year. There is some inflationary pressure on our industrial resins, but again, our contracts will help manage this, possibly with a slight delay. Overall, we are also managing potential inflation in freight costs, but it should not significantly affect our margins as we finish out the year.

Okay. And then just, Nick, if I could squeeze in just a quick one for you, but this A350 freighter opportunity. Could you just speak to that for a moment? It sounds like that would be good. And would an aircraft like that have more or less carbon fiber content?

Well, obviously, from our perspective, more fuel-efficient, advanced lightweight aircraft that have a life of 30 years is a great thing, and especially the A350 being adopted as a freighter variant is exciting for us. So, obviously a good thing. We do not anticipate a significant change in the shipset content going from a passenger version to a freighter version. But, we’re certainly excited and hopeful that both Airbus and Boeing launch new advanced aircraft for freighter versions going forward.

The next question is from John McNulty from BMO Capital Markets. Your line is open.

Maybe just two related ones on the cost side. So, Nick, you had indicated you were adding labor, weren’t really having any problems with that. Should we be thinking about that as normally, when you bring up a new facility, there’s a little bit of a ramp-up or a learning curve and there’s some inefficiencies early on. Is that something we should be assuming with the people that you’re bringing on now, or are these more experienced? And then, I guess, the second question would just be on the R&D front, where right now you’re kind of running at a 20% or 25% lower level than you had kind of in the pre-COVID world. I guess, can you speak to the efficiencies that you’ve learned and can you kind of work with, in that lower cost environment? And how we should be thinking about R&D ramping up as we look forward over the next year or so?

Okay. So, let me start with the R&T. We certainly would expect R&T to grow above second quarter levels, and we’re putting plans in place for that as we speak. With respect to labor and efficiencies, many of the add-backs have been experienced Hexcel employees. Throughout my visit, it was exciting to welcome them back and to see the excitement in their eyes, and motivation and enthusiasm. So, we really have not had any issues in bringing back experienced people. Certainly anticipating some tightness in those markets, and we’re being pretty aggressive in how we’re recruiting, posting, advertising, and staying prior employees. But to really answer your question, we don’t see a big learning curve or think that you should anticipate one.

Our next question is from Gautam Khanna from Cowen. Your line is open.

Yes. I was wondering, Patrick, could you elaborate on where you’re seeing some continued destocking, like which widebody program or programs?

Well, I think the simple answer is all of them. We’re less involved with the A350; we’re likely to get through that program's destocking first. This ramp-down occurred a bit earlier and faster than expected. The 787 ramp-down from 14 to 10 to 6 to 5 likely happened a little later. While this may be separate from the pandemic destocking, there are currently some delays with the 787. I believe the destocking will be minimal, but it could continue later in the year. So, it involves all widebodies, but hopefully, the A350s will finish soon, and the 787s will extend a bit longer.

Are you noticing that, in general, your widebody production is below the official assembly rate for Boeing and Airbus, while your narrowbody production aligns with the official assembly rate? I'm curious because we've heard that some in the supply chain are producing three A350s a month, whereas Airbus is reportedly assembling at a higher rate. In terms of destocking, does this mean you're aligned with the assembly rate for narrowbodies but not for widebodies? Thank you.

So, I’ll take a shot at that. So widebodies, clearly, we were well under the production rate stated by the OEs. And again, that’s the supply chain adjustment, the destocking, to get down to the new stable rates. The narrowbodies, basically, we’ve seen that wind down with respect to the delta between the stated OEM build rates and our ship to rates. And pretty much based on the demand, the visibility that we have with the OEMs and their supply chain, which we’re paying very close attention to above and beyond what we typically do, we’re seeing that subside. And that’s why we have confidence that the narrowbodies are pretty much behind us with potentially just immaterial amounts carrying on. The real items will be the widebody and some trickle through the summer.

Our next question is from Myles Walton from UBS. Your line is open.

Patrick, I think you said that you expect ‘21, just from a sensitivity perspective, to be below 2020 sales, and that consensus, you’d be below that. And I don’t think consensus has moved since last quarter when you thought you’d be in line. I’m just curious, is the only change that you’ve seen sort of that maybe 10 or 15 fewer shipsets on the 787 because of what Boeing is doing, or are there other moving parts as well?

Well, there’s a million moving parts, but the most significant thing is definitely the 787, Myles. Yes.

Okay. But from a magnitude perspective, that’s what the delta is?

Yes. From a materiality perspective, that’s the largest for sure. Yes.

Okay, perfect. There was a strong margin performance in composite materials. You mentioned the carbon fiber mix, but I would have thought that the industrial mix as a percentage would have negatively impacted you. I may not have the exact context, but I assumed that industrial margins would typically be lower, and it seems that the industrial mix performed better than your aerospace and defense mix. Was there something unique about the industrial mix that limited its negative impact?

No, you're correct. The only thing I can point to is the absolute dollar amounts for those industrial sales compared to the euro sales and the higher fiber sales, which obviously has some downward pressure. There is a minor dilutive effect. You’re absolutely right. However, considering the relative dollar values of the sales, it becomes very marginal overall.

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

Hey Patrick, could you share more insights on the margin trends for the second half of the year? It seems like you might have some idea about the mix for the third and fourth quarters. Also, you mentioned the increase in capacity utilization, so do you have a sense of how that will play out? Will the third quarter reflect a slight decline despite higher volumes, with the fourth quarter being the peak for the year? I would appreciate any additional details you could provide on this.

Yes. I’m really not going to get into a quarterly guidance on margin cadence. I mean, what I will say is, I pointed out 3.4%. I said it’s going to be low single digits for the whole year. I’ll go as far as saying, I don’t think there’s going to be anything dramatically different between Q3 and Q4. But, I think we’re not going to get into quarterly specifics.

Okay. Fair enough. Maybe just one last question from me. I thought you had an interesting announcement earlier this month regarding your work with an automotive suspension provider, and there was mention of them being a mass production automotive supplier. I'm curious if you feel this could be a significant breakthrough in the automotive sector for your company, or if it's too early to tell, or how promising this opportunity might be.

Well, I’m not going to go as far as to say a big breakthrough, but I am excited with the advancements that our team continues to make on new products, new processes, not only for structural, but for quick curing to make the solutions even more efficient. So, we continue to do very well with European car manufacturers and BMW being one of the leaders in that pack. So, again, we have multiple initiatives underway to work with our customers to help them identify solutions that put them in a better position to win in the marketplace. So, we feel good about that and we look forward to continued growth.

Our next question is from David Strauss from Barclays. Your line is open.

Nick, as we think about into ‘22 and ‘23, just given the level of the magnitude of destocking that you’ve seen, would you actually expect to see a bit of a restocking effect on the other side? So, what I’m implying is that your rates could be above the actual manufacturer production rates as we get on the other side of this, at least for a little bit of time.

That’s a great point, David, and we’ve actually spent a fair amount of time making sure we’re not surprised by some incremental buffer that will be required in the various supply chains. Obviously, the A320, with the most aggressive and near-term ramp rate is an item we’re looking at, but widebodies as well, as the rate starts to come back, I do think some of the supply chain probably has driven down their inventory to preserve cash and may be tighter than what they can run at higher rates. So, we’re definitely putting that into our forecast and our evaluation to make sure we’re not caught short.

Okay. And Nick, could you just maybe level set up in terms of where you stand from a capacity utilization standpoint today, thinking mainly on the composite material side?

Utilization? Capacity utilization varies. I mean, in my tour of the U.S. sites, I saw sites that were basically running full out and areas within plants that are basically at or near capacity, while we have other assets and sites idled. So, around fiber, Patrick pointed out that we continue to ramp up precursor and carbon fiber assets throughout the year, and we plan to do more before the end of the year. But, we still have a fair amount of capacity in place that will prevent the need for major CapEx investments for a few years.

Our next question is from Paretosh Misra from Berenberg. Your line is open.

Can you talk about your other commercial aerospace category, the business and regional jet? In terms of what sort of build rate and demand ramp-up are you expecting in the second half, and how are the inventories in that business are looking?

Well, we don’t specifically get into build rates. I can tell you, we’re excited on the new platforms, some of which are just coming into production with Gulfstream. We’re excited with the opportunities we have with Dassault and potential big wins in that space. Obviously, similar commercial aerospace, there’s a migration to more efficient composite aircraft and components, and we love the space for that. Clearly, there’s a long way to go to catch up with pre-pandemic levels. But, we’ve seen some optimism with respect to hours, flight hours and the demand on the biz jet, especially the larger class size. And again, we remain excited and bullish on that for the balance of the year.

Thanks for that, Nick. And maybe if I could ask one more. Just going back to the labor issue, given the narrowbody build rate ramp-up ahead, do you have any sense as to how much in terms of headcount increase you’ll have to implement over the next 6 to 12 months?

Well, we’re not going to give that. Perhaps when we give next year’s guidance, we’ll elaborate a bit. But, I can tell you, one of the specific sites I visited in the last couple of weeks has recently ramped up, calling back 100 people. So, every site is different. We’re bringing people in as the demand necessitates. And we’re pretty much in lockstep. I would also say, we’re continuing to drive the continuous improvement projects. So, we’re even bringing in some labor to work on those advancements and productivity enhancements that will pay dividends down the road as rates return.

Our next question is from Robert Stallard from Vertical Research. Your line is open.

Nick, since the last call three months ago, we’ve seen Airbus give an update on its build rates and not really much change on the A350 looking out over the next couple of years and, of course, Boeing also couple of 787 again. So, I was wondering if this news has pushed out your expectation for when the widebody side of your business will get back to full rate.

Actually, it hasn’t. I’ll tell you, again, this is from my perspective after getting out in the U.S. and hitting every one of our sites, seeing how our team has rapidly ramped back up to travel to visit customers, to visit suppliers, to visit our sites. There’s no doubt in my mind, global travel is going to come back and it’s going to come back strongly. Now, vaccines have to accelerate; borders have to open up, but I can tell you for myself, to get into Europe, to visit our sites, to visit our customers is imperative going forward. So, personally, based on all the data and all the market news that I keep up on, I’m more optimistic on business coming back quicker than was anticipated six, twelve months ago.

Our next question is from Richard Safran from Seaport Global. Your line is open.

So, I wanted to ask you first about space and defense, specifically rotorcraft. Lockheed noted some improvement in rotorcraft, helicopters. So, on that segment, I don’t think I’m going out on a limb here saying you really outperformed in 2Q. So, I was wondering if you’d comment on, with respect to what you’re seeing in space and defense with rotorcraft, are the RMS results something where we could see a pickup in the back half?

Yes, I believe rotorcraft is performing well. The quarterly sales in 2021 are higher than those in 2020, including the first quarter of 2020. We are seeing a positive trend with the CH-53K and other platforms beginning to make progress. I expect a steady increase for the remainder of this year and into 2022, aligning with our general expectations for medium to long-term low-single-digit growth in the space and defense market, which includes rotorcraft. The commercial and civil helicopter market is relatively small, as it is primarily dominated by military aircraft.

Nick, I just wanted to follow up very quickly on the comment you just made about business jets. Would you be willing to comment if you’re seeing a bit of a pickup in small and mid-cabin aircraft? I know in an earlier quarter, you had made some comments about it. I thought just maybe you have a remark or two on that.

Well, again, I think the traffic, and if you look at the data on used aircraft and the sales are positive momentum. And again, not much more color, other than it pretty much stood out that the large class was leading the pack with respect to the growth and the recovery. I expect and anticipate that the mid and smaller classes will follow soon.

Our next question is from Mike Sison from Wells Fargo.

This is actually Richard on for Mike. Just on the Industrial segment, just curious, you noted strength in automotive and recreation. Maybe just a little more color on that. And also, what is the current state of the wind energy market? Have we seen that bottom out? Have you seen any change in sort of customers on their supply chains and that sort of thing?

Yes. So, I’ll take a shot and Patrick can add some additional color. With respect to the industrial market, again, there is 30-plus segments in there, and we participate, monitor, contribute to all of them. Obviously, the automotive, we’ve got certain differentiated technology; we continue to push. We continue to work with the OEs, especially on the premium end and the high performance, to find opportunities where we can differentiate and offer advanced solutions utilizing our technology and materials. Marine has stepped up nicely as well as recreation. And we’ve got various wins within both categories, none of which individually moved the needle significantly, but they all add up and we continue to pursue those. So, Patrick?

Yes, I think that’s correct. Reflecting on Myles’ question, it's important to note that some of the products we supply to the industrial and high-end automotive sectors include woven carbon fiber. The margins associated with these product lines are not significantly lower than those of some aerospace lines. Overall, they are generally lower on average, which has a slight dilutive effect. However, there is a mix involved. As Nick mentioned, the high-end automotive sector demands a lot of fabric, which presents an appealing business opportunity.

Great. And then just on, I guess, the composite materials, the increased mix of carbon fiber that you mentioned, do you expect that mix to continue to be the same for the rest of this year, or what’s your expectation?

Well, what I tried to kind of allude to that in the script, it’s going to be a little bit lumpy. I mean, we’ve obviously got the growth we have now, but as other product lines come back, the mix gets diluted a bit. And so, we will occasionally see a step-up in carbon fiber, and that will help a particular quarter and give us a boost. I mean, I’m not talking significant changes quarter-to-quarter, but it depends on the overall mix. I wouldn’t assume that every single quarter is going to get the same carbon fiber mix boost. I think that’s the simple answer.

Our next question is from Sheila Kahyaoglu from Jefferies. Your line is open.

Patrick, you may as well give guidance at this point because we’re asking all the questions anyway. But on the 787 destocking lingering a little bit longer, can you tell us how you’re thinking about that lingering? And what that impact on profitability would be, given last quarter you quantified or kind of gave us some guidelines on the A350 and what that would mean for profitability?

The connection is a bit unclear, Sheila, but I believe you were inquiring about the impact of the 787 for the remainder of the year. We don’t have specific details at this point. Boeing has indicated that they will be operating below grade 5 for a certain duration. We are monitoring that closely and will adjust as needed. After experiencing a significant destocking due to the pandemic, we hope there won’t be much impact, but some might still occur, as I mentioned earlier. We are staying flexible, and this links to my earlier comments on the revenue expectations for the year, as we will definitely see effects from the 787 adjustment. You also mentioned the A350, Sheila. Could you please repeat...

Yes. Sorry, Patrick, if you can hear me now. Regarding the A350, last quarter you indicated that when you were producing five per month, you experienced peak margins in the double digits. How do we view the impact of the 787 on your profitability profile?

Well, I mean, the 787 is a great program. It’s obviously a smaller program than the 350 for us. We want all the programs to come back. I mean, the point we were making was specifically, we were kind of trying to tell the world, don’t think we have to get back to rate 10 on the A350 in order to make mid-teens plus margins. So, that was the specific point. Now, obviously, if we can bring back 787 sales and the A350 creeps from 5 to 6 and upwards, that’s just going to help boost us to mid-teens and high-teens performance.

Our next question is from Noah Poponak from Goldman Sachs. Your line is open.

Patrick, if I just plugged in your 2Q operating margin into the third and fourth quarter, it would make the full year shake out to something in the mid to high 4s. So, by guiding to low-single-digits, if I define that, it’s below 5. It sounds like you’re telling us that the third and fourth quarter will average something less than the second quarter. Is that fair?

Your overall shape is about right, Noah. Let’s say that. Low-single-digit is below 5. Yes, I agree with that.

And the discussion on the longer-term margin and where it can be when you’re back to $1.8 billion to $1.9 billion of total company revenue, where you were a few years ago. At that point in time, the margin was kind of 17%, 18%. In calling it mid-teens rather than just getting back to where you used to be, is that purely a function of widebody, and you can be a little bit below where you used to be, but close with much lower widebody rates because of everything you’ve done on the cost side, and you would just need widebody closer to where it used to be to get all the way back?

I think it’s really just the degree of specificity that we’re putting out there. I mean, we’re saying mid-teens plus. We could be 16%, 17%. We’re obviously looking to drive it as much as possible, as we called out previously, holding on to as much $150 million overhead takeout to overcome the depreciation headwind is a key part of this. A little bit of mix is going to impact it. But absolutely, when we get to the $1.8 billion, $1.9 billion level, we will be looking to push to the same levels we were previously. Perhaps we’re being a little bit cautious in saying mid-teens plus, but we will be driving it as strongly as we can.

Got it. And just last piece of that, obviously, you have much higher depreciation today than you did in the historical period of time you’re referencing. Is that the entire depreciation variance you're referencing, or is there still a little bit more of that ahead of you?

Well, I mean the depreciation difference is going to be what, $60 million, $65 million? That’s essentially what I’m talking about as the headwind.

Okay. And that being today versus, call it, 2016?

Yes. I'm looking ahead to a year or two when we aim to reach $1.8 billion or $1.9 billion, and our depreciation is not expected to increase significantly. I'm reflecting on the levels from 2015 and 2016.

Our last question is from Ron Epstein from Bank of America. Your line is open.

Maybe just a question, a bigger picture question on composites in general. And maybe in two parts. One, where do we stand on cold cure and the ability to get composite throughput quicker? Because that seems like that would be something that would be good for future narrowbody. And then, two, how should we think about the recent issues on 787, and what that means for composite usage on aircraft, given the production difficulties that they had? Is that just a Boeing-specific thing, or is that a composite thing?

First, I'll address the cold cure. Whether it's about cold cure or speeding up cure rates along with increasing laydown rates, and whether autoclaves are necessary, all of this contributes to the growth in aerospace. Clearly, this is a major focus for us, whether we're discussing industrial applications for automotive or collaborating with original equipment manufacturers on new narrowbody materials. The efficiency in curing and the capability to produce more near-net shape products using composites will continue to improve, leading to further growth. Regarding the 787, we must remember that airplanes are complex systems. There have been past issues with aluminum and metal planes. I believe this is a situation where some issues were identified due to the increased scrutiny from Boeing on their products, and they've acted quickly to address it by lowering the production rate of the 787. I expect them to overcome this challenge swiftly. Additionally, both Boeing and Airbus, along with many other clients, have discovered that composite manufacturing processes have advanced significantly, and the efficiencies and cost advantages in processing are substantial. Composite airplanes are relatively new compared to metal ones, but the progress is impressive and will keep advancing. I see this as a production development matter that will be resolved, and composites will continue to thrive.

Thank you, speakers. Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. And have a wonderful day. You may all disconnect.