Ladies and gentlemen, thank you for standing by, and welcome to the Hexcel Q3 2020 earnings call. At this time, all I would now like to hand the conference over to your speaker today Patrick Winterlich, Chief Financial Officer. Please go ahead.
Thank you. Good morning, everyone. Welcome to Hexcel Corporation's 3rd quarter 2020 earnings conference call. Before beginning, let me cover the formalities. First, I want to remind everyone about the Safe Harbor provisions related to any forward looking statements we may make during the course of this call.
Certain statements contained in this call may constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments, and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward looking statements today.
Such
factors are detailed in the company's SEC filings and last night's news release. A replay of this call will be available operation and its copyrighted material. It cannot be recorded or rebroadcast without our expressed permission. Your participation on this call constitutes your consent for that request. With me today are Nick Stannage, our Chairman, CEO and President and Kurt Goddard, our Vice President of Investor Relations.
The purpose of the call is to review our third quarter 2020 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 as we share our third quarter results. The impact of based business becomes more evident every quarter. The results we shared in our news release last night reflect the ongoing decline in sales resulting from global quarantines, shutdowns, and social distancing that will continue until the world redeems at confidence in their travel again. In the meantime, we are adjusting and making decisive business decisions to position ourselves for growth on the other side of the pandemic.
Yet relatively steady increase in fully returned to pre pandemic levels, and the world now must navigate a challenging winter season ahead. We expect that inventory destocking will continue to impact production levels throughout the entire supply chain. And consequently, We are preparing our business for channel adjustments that could take another 2 to 3 quarters to fully work through the system. Our fundamentals remain unchanged programs with our advanced composite technology and the broadest portfolio in our industry. We continue to generate cash flow and further strengthen our balance sheet.
Us in a strong position to weather this storm. Execute and to work through them. As we mentioned, our objectives during our 2nd quarter earnings process we have reduced labor costs by roughly 30% and have eliminated more than 2000 positions. We have idled various assets to keep overhaul capacity aligned with demand, and we are focused on reducing inventory and maintaining a lean and streamlined internal supply chain. We have cut overhead costs by reducing and eliminating discretionary spending, reducing benefits Like so many others, our team made sacrifices as we took action to stay in lockstep with our customers.
Our team has accepted pay cuts, furloughs, and shorter workweeks. The staffing was trimmed. Others added to their workflow. All of this was done with the knowledge that this downturn is not the position our company to emerge even stronger when the pandemic subsides. We're taking advantage of the time to refocus, restructure and draw on our resiliency to ensure that we continue to deliver strong shareholder value.
Global demand its will grow, and our technology and broad portfolio remains unrivaled in our industry. In addition, we have the most talented, diversified and experienced advanced composite material science workforce in the world. Those things have not and will not change. Now I'll share with you some of the numbers we reported last night. Sales in our 3rd quarter were $287,000,000 or about 50% down year over year.
Adjusted diluted EPS was negative $0.29 compared to $0.90 in the third quarter of 2019. Despite negative adjusted operating income, we generated $76,000,000 of free cash flow during the quarter. Which brings our year to our debt levels are now an undrawn revolver balance of $698,000,000. As part of our normal business cycle, plus further tight as a result of the pandemic, capital expenditures this year are sharply lower than the past few years when we were investing in additional capacity for program ramp will provide the foundation for a long period of strong Now turning to our 3 primary markets. Commercial Aerospace sales continued to decline last order as global passenger air traffic remains at about half twenty nineteen levels.
Build rate reductions, driven by the pandemic, combined with significant inventory destocking, led to the reduced sales levels. All major programs were down substantially with the largest sales impact related Additional build rate reductions publicly announced at theendofJuly by Airbus And Boeing are further extending the supply chain to stop However, we are encouraged as the 7 37 MAX who is closer to recertification in the U S, Europe and Canada. As a reminder, while the A350 is Hexcel's largest content program, the narrow body such the A320neo and 737 Max carry substantial Hexcel content in the engines and secondary instructions. And they are typically produced at much higher build rates. Hexcel will benefit significantly when narrow body demand increases.
For example, the Airbus backlog for their A320neo family is basically unchanged year to date, despite pandemic and 9 months of production. At current production rates, Bob represents 13 years of production, illustrating that medium to long term demand for these aircraft remains roll lost. Regional business aircraft sales fell by about 50% during the third quarter compared to 2019. This is an area we are watching closely as increasing flight time for the smaller class business jet indicates an encouraging trend. In contrast with commercial aerospace, our Space And Defense sales remained steady year over year.
We experienced growth in U. S. Defense platforms. Overall, we remain confident with continued strength of Space And Defense as HEXL is positioned on diverse program including military aircraft, flight vehicles, launchers, helicopters, both civil and military, including growth programs such as a CH53K and Airbus H160. We see a lot of positive momentum and tremendous opportunities ahead.
And I want to point out our ART Technologies acquisition continues to perform exceptionally well. Space And Defense now represents about 27% of our year to date sales compared to to 19% for and changes in the wind energy business. Specifically, the sales decline in our wind energy segment reflects competitive pressures have led to a shift in demand from our advanced flask fiber prepreg to lower cost products. As a result of this demand change, in early November, we will close our wind energy preproduction facility in Windsor, Colorado. I want to be clear in stating that our relationship with our largest wind energy customer, Vestas, remains strong.
While we anticipate the continued cost pressures for future wind turbine blades, we expect to maintain our market share and legacy blades and replacements for many years to come. In addition, we are working today to technologies and solutions to help our wind energy customers enhance the performance of their wind turbines further and continue to drive the economic case for wind energy as a source of renewable power. In addition, we've been working successfully for several years to grow our automotive, marine, recreation, and other industrial businesses. And we continue to see good growth opportunities in several niche industrial markets. Our industrial team is excited by the opportunities and interests we've received on our materials, our engineered products and our solutions around the globe.
This was another challenging quarter for our business and we expect further disruptions before this pandemic ends. Still, Hexcel remains a global technology leader with strong business execution and a great investment. Market challenges have forced us to make tough decisions, and we have significantly reduced headcount and continue to restructure the business. In the end, though, we have never taken our focus away from innovating new technology and solutions to position us for new opportunities to grow the business, drive operational excellence and develop even stronger relationships with our customers. Speaking of customers, let me take a moment to say that even though this has been one of the most difficult times we've faced, we can't ignore some of more positive outcomes from this crisis.
One of them comes from the need to think and act differently as we deepen our customer relationships during these months of social distancing and limited travel. For example, we are now spending quality time interacting with customers through virtual technology meetings. We're getting more of our talented team in touch with our customers than ever before. Without a doubt, the way we do business is changing and we are embracing it. Now, I'll turn the call over to Patrick to provide more details on the numbers.
Thank you, Nick. As a reminder, the year over year comparisons are in constant current see. 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 strengthened against the euro and the pound, our sales translate lower, but our costs also translate lower, leading to a net benefit to our margins.
Accordingly, a weaker dollar as we currently facing is a headwind to our financial results. We hedge this currency exposure over a 10 quarter horizon protect our operating income. Quarterly sales totaled $286,900,000, The reduction in sales year over year is due to the significant and rapid production rate decreases by our customers in response to the pandemic. Compounded by aggressive supply chain destocking across our product lines. And you will recognize that is build rates have fallen any given level of inventory in the supply chain will now represent a greater number of months of demand.
Perspective, Hexcel last experienced this level of quarterly sales a decade ago, Over the past decade, aerospace concierge options has grown markedly and Hexcel has won a significant share of the market opportunities. During this time, we have expanded our intellectual property, broadened and beaten our customer relationship, growing our global manufacturing presence, while simultaneously enhancing our operational excellence and significantly strengthening our balance sheet and liquidity. I shared both to illustrate the magnitude of the current destocking impact and as a reminder that destocking will end and gradual restocking will begin when production rates rise again. Turning to our 3 markets. Commercial Aerospace represented approximately 45 percent of 3rd quarter sales.
Commercial Aerospace sales of $128,800,000 decreased 66% compared to the third quarter of 2019. This large percentage decrease illustrates a daily additional impact of the destocking. For reference, 2 key platforms, the Airbus A320neo and the A350, had production rate decreases of 30 3% 50% respectively. Additionally, the Boeing 77 MAX sales were substantially lower year over year as production continued at a very low rate, and there remains a higher amount of inventory in the supply chain. As Nick outlined, we expect commercial aerospace supply chain adjustments to continue into the first half of twenty twenty one.
Spacing defense represented 38 percent of 3rd quarter sales and totals $108,800,000, a decrease of 0.5% compared to the same period in 2019. U. S. Space and defense sales increased year over year While the European Space And Defense sales decreased, we remain bullish for the outlook of our Space And Defense business globally Industrial comprised 17% drill sales totaled $49,300,000, decreasing 38%. Wind Energy weakness continued from the second quarter of 20 20 as our major wind energy customer shifted their U.
S. Blade operation to an outsourced model rather than using Excel's fast fiber composite material to manufacture the blade in house for the Americas region. As a result, we are closing our Windsor, Colorado facility in the fourth quarter of 2020, which was dedicated to Wind Energy. I planned to remove some of the equipment to another Hexcel facility in the U S, and then sell the Windsor site. Our wind energy facilities in Austria and China continue to operate serving the European and Asian markets, respectively.
Automotive, Recreation and other industrial markets remained weak during the third quarter, reflecting the continued impact of the pandemic. On a consolidated basis, gross margin for the third quarter was 4.7% compared to 27.6 percent in third quarter of 2019. As we discussed at our last earnings call, We temporarily either will select carbon fiber capacity during the third quarter, and this has continued now into the 4th quarter to align supply with demand and avoid overproduction. Mix, particularly lower sales in our carbon fiber, also remain an earnings headwind. We are continuing process improvements and cost realignment actions across the business and we remain agile and vigilant as we communicate frequently with our customers and assess near term demand indicators in relation to the realignment actions that we have taken.
Selling, general and administrative expenses decreased 28.3 percent in constant currency or $9,200,000 year over year as a result of head ad reductions and tight controls on discretionary spending. Research and technology expenses decreased 25.8 pending constant currency as we selectively reduced costs while continuing to balance our needs for innovation as a material science company operating an industry undergoing long term secular growth. The other expense cap period includes the restructuring costs to close our Windsor, Colorado facility, as well as severance costs,
primarily in Europe. We will be
incurring additional severance costs in upcoming periods, including further labor reduction actions already initiated in Europe. As Nick mentioned, we have unfortunately had to eliminate more than 20 positions after the roughly 7000 positions we had at the beginning of the year. This reduction includes direct and indirect employees. Additional labor actions as well as furloughs and short time working have been initiated that will continue through year end and into 2021. As you would expect, we are real we are aligning raw or direct raw material and direct labor costs in line with demand changes across our company.
In addition, as called out in yesterday's earnings release, we've put in place actions to realize more than $150,000,000 with annualized overhead run rate savings, including indirect labor. Once we are through the normal lag of these cost reductions to take full effect, Adjusted operating loss in the third quarter totaled $21,800,000 as the low sales levels have led to significant under absorption of fixed overhead. The year over year impact of exchange rates was negative by approximately 40 basis points. Now turning to our 2 segments. The Composite Materials segment represented 75% of total sales and generated a negative 9% adjusted operating margin compared to 21.2% margin in the prior year period.
Engineered Product segment, which is in comprise of our Structures And Engineered Core Businesses, represented 25% of total sales, and generated a negative 3.8% operating margin compared to 16.3% in the third quarter of 2019. As we progress through the pandemic, we are continuing to evaluate every aspect of our business, including the structure of our various legal entities. Following an internal reorganization, we recognized a discrete tax benefit of $43,900,000 during the third quarter of 2020. We are not providing guidance on an effective tax rate going forward at this time due to the complexity of our tax situation as a result of the pandemic and the relative mix shift in our global income pattern. Net cash provided by operating activities was $83,400,000 for the third quarter of 2020 $157,000,000 year to date.
Working capital was a source cash of $80,700,000 in the quarter. We expect working capital to be a source of cash during the fourth quarter of 2020. Capital expenditures on an accrual basis were $6,000,000 in the 3rd quarter compared to $53,300,000 for the prior year period in 2019. We continue to tightly manage capital expenditure Free cash flow for the third quarter of 2020 was $76,000,000 compared to $56,700,000 for the comparable prior year period, we remain focused on generating and preserving cash. To generate additional free cash flow in the fourth quarter of 2020 as we continue to manage inventory levels and maintain strong receivable collections.
We increased our liquidity by $77,000,000 as of September 30, 20 20 compared to June 30, 2020 further strengthening our balance sheet. Our total liquidity at the end of the 3rd quarter was $766,000,000 consisting of $68,000,000 of cash and an undrawn revolver balance of $698,000,000. We have no near term debt maturities, our revolving reserve in 2024 and our 2 senior notes since you're in 2025, 2027, respectively. When markets are predictable, we operate with only a minimal cash balance as our business generates cash. Based on our confidence to continue to generate free cash flow.
In the fourth quarter of 2020, we completed the repayment of the proactive million revolver borrowing that was drawn in March in the early days of the pandemic. Our leverage as of September 30, 2020 is measured on a gross debt basis and was 3.25 times compared to 2.8 times and June 30, 2020. The change was due to lower 12 month trailing earnings as net debt decreased $77,000,000 at September 30, 2020 compared to June 30, 2020. We remain within covenant conditions. We recently worked with our bank's indications to accommodate a temporary impact to child destocking by amending the revolver leverage covenant for a period of four quarters and temporarily changing the covenant to a net debt basis.
For up to $200,000,000 of cash. This amendment illustrates our solid bank syndication relationship and preserves our access to liquidity via the revolver. Our share purchase program was suspended during the third quarter of 2020 and is now also restricted by the recent revolver amendment. Our forward will continue to evaluate capital allocation priorities Our focus remains on realigning the business and generating cash while remaining agile for future growth and channel restocking when production rates have increased. With that, let me call turn the call back to Nick.
Thanks, Patrick. The effort the responsiveness and the way our team has adapted to this unprecedented time has been nothing short of outstanding. The commitment, the energy, Our team is controlling what they know they can control and taking action to make sure we're ready for growth as it comes back. The future of aerospace is about lightweighting, improved aerodynamics, and sustainability. And I can tell you There's nothing that addresses those needs better than HEXL's composite solutions.
We continue to invest in innovative research and technology. In August, we launched a new product in our additive manufacturing product line that integrates advanced electromagnetic performance from our ART Technologies acquisition into thermoplastic 3 d printed parts for commercial Aerospace And Defense. We're always thinking about how we can help our customers succeed And that's evident, especially in this new product, because it eliminates secondary processing steps, which otherwise would add cost and consume more manufacturing time and assets. We're not taking our foot off the gas staying focused on winning that next new program because our sites are on long term growth, long term relationships, and long term sustainable value generation product shareholders. We're also aggressively pushing many near term opportunities especially in areas of space, defense and industrial where we continue to see strong pull for our Advanced Materials.
We are a leader in advanced composite solutions that has not changed and it never will. Going forward, our focus is clear to generate and tightly manage cash and further strengthen our strong balance sheet while at the same time positioning ourselves for the demand recovery ahead. We're ensuring that we're aligned with customer demand and positioning ourselves be ready to deliver strong incremental margins. We know that we have more tough times ahead. I challenge our team to work safely, to stay aligned with customers' evolving technology needs and production demands.
I know that I can rely on them to deliver because commitment to excellence is bred into our 1 Hexcel culture. Kenzie, we'll turn it over to you and now take questions.
Our first question comes from the line of David Strauss with Barclays. Please go ahead. Your line is open.
Thanks. Good morning.
Good morning, David. Good morning.
Nick, I want to try touch on this, on the destocking. Can you just touch on the visibility you think you have today versus 3 months ago and your confidence that this kind of takes care of itself over the course of the next 2 or 3 quarters. And then it would appear that you're seeing a much bigger destocking impact relative to, to others in the supply chain and maybe touch on what think is different or unique about you guys as compared to others and what we're seeing there?
Yes. Thanks, David. So a couple of points. First, just as a reminder to everyone, remember, we shipped our advanced materials in advance of the build by as much as 6 months. Our pre pregs, especially have to be frozen.
So if you think about our 2019 commercial aerospace revenue in the $1,600,000,000 range, think of 6 months of inventory, even scale it back to, say, 4.5 months, $600,000,000 of inventory in the supply chain that we ship that is in the tier 1s, twos, threes, making parts along various aspects of the build cycle. If you, if you look at that and think about reducing that by a third, that kind of calibrates your the magnitude of the supply chain adjustment required. Now what gives us confidence in what it would seem? So clearly, from Q2 to dynamic. We've seen and continue to learn more about travel patterns and slow recovery for domestic and even slower recovery for international travel.
Having said that, we New Q3 was going to be a big destocking quarter and we expect Q4 will be another a de stocking order, and it will still linger into, 2021 in the 1st couple of quarters. Then Let me remind you that rates have continued to creep down, can. So I think we have as good a line of sight as you can have in the middle of the pandemic, knowing what we know today, We feel more and more confident as we're looking, to right size our business and our supply chain and around 30%. Might we expect those decrementals to drop a bit going forward? So with respect to the commercial revenue going forward, we certainly see Q4 being very challenged with another, material amount of destocking happening.
We expect destocking to trail down and carry over into next year, but our belief is it won't be to the magnitude that it is today. So I really don't want to get into tradricting the bottom. I'm, I'm hopeful that we're at or near it, but, I really don't want to get into, guidance on what our commercial aerospace sales will be in the first quarter or second quarter next year. Patrick on the margin?
Yes. Hi, Rob. So in relation to the margins, yes, 46 percent in the quarter as you know. We obviously lose a lot of variable margin as our top line comes down. We have a pretty strong variable margin percentage.
And so as revenue comes out, we lose a lot of that sort of coverage of our overhead base. And that really that drives the strong incrementals. I mean, if I can just sort of counter that for a second on the way back up, it's going to drive very strong incrementals as we leverage our sort of overhead base especially now that we've taken out the additional cost. In terms of the 46%, I would see that as a kind of a low point We should start to see that soften or improve, whichever way you want to look at it as we go forward, partly because We're kind of realizing the cost. We're taking out those costs we've talked about on an annualized basis.
More of that's going to come through And hopefully, as just even small increases in our top line are going to help offset some of that detrimental impact. But, I hope that kind of gives you a shape. I would see that as kind of a low point in decrementum.
It does. Thank you.
Our next question comes from Ken Herbert with Canaccord.
Yes. Hi. Good morning, Nick and Patrick. Good morning, Ken. I wanted to follow-up, Patrick on the working capital mean, you did a good job in the quarter.
Clearly, you've called out, opportunities as well in the fourth quarter to sounds like take inventory and working capital should be a source of cash. Inventory levels are still relatively high. How do we think about working capital here, maybe some more specifics into the 4th order, but then as a source of cash into the first half of twenty twenty one, balanced against when you might need to start to just sort of restock or invest in some material again.
Yes. Thanks, Ken. So working capital in the third quarter was just under $81,000,000 as a source of cash. That was clearly a strong release of cash from working capital and you can only take it down so much relative to the overall business demands reduction. I do see further opportunities in inventory.
I'm not going to call out specific numbers. Receivables are probably going to start leveling off as our payables. But I do see a working capital benefit in the fourth quarter of 2020. As we start to stabilize and level off as we so we are working capital. And so there comes a point where we're going to kind of level in terms of releasing any more drama.
I think that's what you were alluding to. We should see some sort of what I call stability in our working capital level as we go into 2021. Then as we kind of move into the second half of the year and we start to see a little bit of growth our working capital will be in a very disciplined and controlled way potentially starts to grow again as you would expect.
Our next
question comes from the line of Richard Faffron with Seaport Global.
Good morning. How are you?
So I thought one of the more interesting comments in your release was the statement about expecting I think you said a significant upturn in 2022. I thought you might tell us where the confidence comes, to make that statement. I felt that you might elaborate on that bit more. Maybe you could touch on, for example, which platforms you see as the major drivers in the recovery?
Okay, Richard. I'll take a shot at that. So, in general, it's not one thing, but, from our view, people wanna travel. People want to get out, go places, visit, and as the borders open up, as, medical advances continue as vaccines are released. People are going to get back travel.
I believe there's a huge pent up demand. And even on the business side, businesses need to get out, visit customers, visit sites, do business. And I believe that's going to recover, again, as the pandemic and the understanding and the social distancing and the new processes and procedures give opponent. So that's the good thing. 2nd, if I look at, what we're going through today, the stocking, destocking is a one time effect.
Now, granted it's layered on by program and every production cut takes more destocking, but it is one time. And once it's done, as you're right sized, there's a tremendous up opportunity for once the growth comes back. Because remember that supply chain will be very lean and our customers and the complex, complex supply chain will be pulling and replenishing that broad supply chain. If you look at narrow body demand, we mentioned it in the script that narrow body A320 backlog, order intakes continued so that the backlog is where it was. Even after 9 months of build rate, we're hopeful and I believe we're seeing more and more confidence a maximum return.
And even though there's a large inventory in that supply chain, we still expect Boeing to ramp up and get their supply chains secured and gradually increase over time. So strong narrow body backlog strong, max, pull that will happen of inventory first and then bill rates will increase. If you look at what we've done, the actions we've taken on the bring on the cost reductions, on the overhead reductions, it's just going to make us even more efficient and able to leverage that growth into incremental margins. So based on what I'm seeing, the pull we're seeing from our customers, even during the challenging time for advanced composite materials to provide new solutions, to provide new ways to drive weight down, cost down, efficiency up. It makes me, And lastly, recognizing wide body recovery probably will be slower than certainly the narrow bodies, and international travel will we lag domestic travel growth.
Having said that, there's a significant amount of park aircraft that will be taken out of service. And as that travel comes back, the replacement aircraft are going to be highly composite intensive newer airplanes where we have strong positions. So it's just a question of when that happens towards the end of 'twenty one, early 'twenty two, think we're in a great position to capitalize on that
Your next question comes from the line of Robert Stallard with Vertical.
Good morning, Robert.
Nick, I was wondering if you could elaborate a little more on what's been going on in the wind sector. I'm sorry, I don't know a hell of a lot about actually. And how much further pressure there could be on the market share situation here? So
And again, as we have stated before, the wind energy market is certainly very competitive. And the cost pressures, they're not new. It's the way the business, has been since I joined Hexcel. If you look at our key customer and others, their ability to compete by being vertically integrated they're no longer able to do that. So they're outsourcing various components to improve their business model.
And that's one of the things that's happened the U. S. Wind market, migrating to an outsourced wind turbine blade for various models. And that wind turbine blade made by outsourced providers do not use a pre priced solution. They use a lower cost, infusion it.
And lastly, we've looked at our Windsor site. We've looked at the cost pressures and the margin in And it just makes no sense for us to continue in that area given our other opportunities with acceptable margins from our perspective.
So could this issue also spread to Europe and Asia as well?
So in Europe, in Austria, we have a broader mix of products, and the more significant portion, our legacy blades, with a high mix. So the likelihood of those migrating is much lower, although there's always cost pressures there, and we're working with our customer to continue to find cost reduction initiatives that we can share with In Tianjin, our wind plant in China, we continue to operate very well today. We continue to work with Vestas. It's no different. There are cost pressures there, and we're closely watching that to make sure we can align with what best this direct and needs are going forward.
So it's a watch item for us.
Your next question comes from the line of Michael Ciarmoli from Truist Securities. Your line is open.
Hey, good morning guys. Thanks for taking the question. Just in light of the destocking that's expected to continue here, how should we think, and again, I guess, taken into context the cost out, you guys have taken out of the business. How should we be thinking about the double digit margin? I mean, is that still a realistic assumption for 2021, assuming we'll have some destocking pressure?
Should we think about maybe exiting the back half 21 with double digit margins? Maybe just some more color there.
Yes. I mean, it's a good question and our margins are going to be pressured for some time. I think it's a little bit early. We're not guiding to 2020 but with the cost takeout, with the realignment we're doing, we're in the process of pulling together our sort of detailed plan and forecast for 2021 literally right now. We are still targeting sort of to push it, it's probably not going to happen as I think you're alluding to in the earlier part of next year.
But as we move into the second part and we continue push, we will be driving towards double digits. And certainly, as we go into 2022 and beyond, we be driving back into those levels and much higher. So not going on to guide for 2021 yet, but certainly with double digit is a target on our horizon for next year.
The next question comes from the line of John McNulty with BMO Capital. Please go ahead. Your line is open.
Yes, good morning. Thanks for taking my question. So it seems like there's kind of 2 destocking issues as the industry destocking and then you're destocking on top of it. And it sounds like by your commentary around working capital improvements where they may end at the end of the fourth quarter, even though the industry destock continues for a while, it sounds like at least one of those pressures on the cost is going to kind of stop, which is pressure that your system is facing because of your own destocking. I guess, how should we think about or is there a way to quantify what that pressure has been?
So as we look to 2021, we don't I assume we don't face that. Is there a way to think about that?
Well, I would give you this color around that. We've been very aggressive to right size our internal supply chain to the point that, we have multiple facilities assets sitting idle as we speak, especially in our high margin carbon fiber assets, we've reduced our production to draw down our inventory to get it right sized so that we can enter the year with more assets online our trained workforce in place and make sure we're ready for that rebound as it comes. So I really don't want to get into giving you a split on dollars of internal versus, external. But for Patrick's point, we expect the bulk of the internal, to be behind us at the end of the year and continue to drive inventory efficiencies, throughput and improvement on days. Throughout next year.
Got it. Fair enough. And maybe just one other thing too. And Nick, you had mentioned at the beginning, your kind of prepared comments a focus on, look, you've got a really diverse platform in terms of your composite. Are you starting to look at other opportunities that may be in past weren't quite profitable enough or hadn't developed enough where we could see some sizable pieces of of incremental volume coming in while you're going through this, what looks to be a potential multi year downswing on the aerospace side?
A great question. And now is the time that's quite unique from Hexcel's perspective. Keep in mind, we've been investing significantly to increase our capacity capacity, So to answer your question, we absolutely are looking at diversifying our capability And that goes not only in fiber assets, it's throughout our internal supply chain and our products, and we are looking at other opportunities. And I'm not gonna their lower margin opportunities, they're great opportunities. They may be smaller volume, more in the niche, more space, and then industrial and specialized areas, but we're seeing a tremendous amount of pull from our customers for those types of applications.
Great, thanks a lot
Our next question comes from the line of Ron Epstein with Bank of America. Please go ahead. Your line is open.
Good morning. This is your outlook
for the destocking outlook. Contemplate the possibility that we could see yet another cut in A350 and 787. Given what's going on in the wide body market?
So we're staying close to our cost and as Patrick mentioned, we're still building out our plan. It's not final. We're getting close to getting ready to get that buttoned up for the year. And we're looking at scenarios both upside and downside. Taking that into consideration.
So I think it will depend on how soon people travel, what international travel does and what the demand for, wide bodies continue to do. I'm still optimistic, the A350 backlog is still relatively strong. And again, it really is going to be driven by a revenue passenger travel. So we're looking at those scenarios.
Got it. And when you think about on a maybe on a go forward basis, maybe from a broader strategic perspective, how are you thinking about diversifying the company? Do you think you need to or not?
Well, do we think we need to change who we are no, we love who we are. We've got great positions. We've got tremendous customer relationships. Do we need to have plans on how we deploy cash, absolutely, because we're going to be a strong, very strong cash generator and we want to drive growth through the utilization of that cash. Obviously, return to shareholders through dividends and buybacks, are another avenue, but our real first priority is to figure out how to position the business for long term sustainable growth.
And M and A landscape and looking at our business through a different lens, it's clearly on our radar as we demonstrated when we were in the midst of the Woodward acquisition. And then Unfortunately, we had to abandon that. So, I'd say we've got a pretty wide aperture on opportunities ahead of us and we continue to look at that.
I guess what I was saying is not necessarily dramatically changing the company. But just broadening your industrial exposure, I mean, there's for sure, given all the changes in industrial end markets, other places you can apply the material science you guys do outside of aerospace?
Well, again, it all comes from it all focuses on technology. We really don't pick, okay, we're going to go after and target this market. This market, we focus on the technology and the high end technology. The things that can scenario or can't be replaced easily. And we're indifferent on whether that's in the space or industrial or wind or automotive or marine.
So our focus is on advanced technical solutions that help our customers, light weighting, on durability, on processing times and getting calls out and it's across the board. So we're seeing tremendous pull in all of our markets to do that. Thank you.
Our next question comes from the line of Noah Popnik with Goldman Sachs. Please go ahead.
Hey, can you guys give us a sense, even if a pretty wide range of how much annualized recurring run rate revenue you're losing to this displacement that occurred in the wind business, just so we can recalibrate that? And then On the aerospace side, when you quantified the inventory in the channel and destocking yet to occur, I was curious if you could specify that on the max since that's so much different, be helpful to know where you stand on that program.
So in terms of wind, I mean, I mean, I mean, you could probably almost do this yourself now, but I mean, guide you sort of industrial historically was lost by 13% of our sales in 2019. About half of that, maybe just over was wind energy. And broadly a third was related to the Americas market. So that kind of should give you a magnitude of what we're talking about. I mean, scheme of things, certainly in the normal year, it's a relatively small amount of revenue, but hopefully that kind of value there for you.
That's helpful.
Yes. And with respect to your question on Mac destocking. That's a huge, unknown. We're being fairly conservative, staying very aligned with going on what their scenarios look like. And depending on how quickly the recertification happens, and the domestic travel picks up and the delivery of the significant amount of aircraft that are already finished.
We're really watching that closely, but we're not going to get into program by program on what kind of destocking we we're building into our forecast.
Sheila Kahyaoglu with Jefferies.
I know you're not guiding, but maybe something that would help us walk through how we could think about your gross margins this quarter and the contraction. Maybe Patrick, if you could bucket for us, what the volume detrimental was versus the mix headwind? And then the idle facility costs And then, of course, you mentioned $150,000,000 of annual cost savings. How much of that was in Q3? And how do we think about the cadence of that as we progress?
So not looking for guidance, just looking for a little bit of a bridge in the quarter just to think about how to frame that outlook?
Yes. So if I start with the savings, $150,000,000 annualized savings, we're now kind of got and we're driving forward and we can see that, as I say, on an annualized basis. Some of that was there in probably a very limited amount was there in Q2. And that will continue to grow now into Q4 and Q1, Q2 next year as we really get it. Flowing through.
So that's going to come off our overhead base, our fixed cost base as a company. In terms of all the margins you called out there, I mean, I think what you have to remember is that Hexcel Drive are strong, and I think I this earlier on, a strong variable margin. So if you take out top line sales, you take out a lot of take out a lot of margin and that, clearly becomes quite a significant headwind, which drives the decrementals that we've talked about. And so whilst we've continued to face these challenging top line beef, as the top line starts to clean up by small incremental steps, that will also help margin me. So we will right size ourselves strong as we can.
We will position ourselves through the end of this year and going into next year. We continue to take cost actions especially in Europe would take time to really sort of play out and we'll see those benefits emerge more strongly as we go into next year. But then as we start to get the top line growth, we'll drive the strong incrementals of that large variable margin. And I talked about and that will really help me position the company. So the $150,000,000 is a significant step in our structural costs.
We will leverage that when we start to see some growth back up
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