Ladies and gentlemen, thank you for standing by and welcome to Hexcel's 2nd quarter 2020 earnings call. At this time, all participants are in a listen only mode. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Patrick Whitrowich, Chief Financial Officer. Thank you.
Please go ahead, sir.
Thank you, Julian. Good morning, everyone. Welcome to Hexcel Corporation's 2nd 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 and is 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 Spanish, 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 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 second quarter results. Looking back at the scenario planning, imagine the specific nature and magnitude of a global pandemic and economic consequences we are experiencing today. Understanding, learning and adjusting in real time to today's realities are essential steps to delivering shareholder value. Our 1 Hexcel team will continue to act quickly and aggressively We will remain vigilant and responsive to our As you saw in our release last night, the COVID-nineteen pandemic had a significant impact on our second quarter sales, operating income and earnings per Once the pandemic's effect on air travel and the global economy unfolded earlier this year, we moved swiftly to assess the steep decline ahead and knew that the impact on Aerospace And Industrial Industries would lead to one of our most challenging years ever.
Commercial Aerospace has been impacted significantly as a result of the pandemic and we expect global flights are down more than 50% and major airlines are flying well below their planned capacity levels. In our commercial aerospace market, demand is down for both wide body and narrow body aircraft, as well as business jets. Our industry currently faces declines in deliveries, orders and backlogs while rising cancellations and deferrals indicate it could take a number of years before we see full recovery. In addition, quarantines, shelter in place orders, social distancing and personal income loss are contributing factors that have negatively impacted our Industrial segment, especially Automotive And Recreation as consumers delay or cancel plans for major purchases. That cover, we readily accept the challenge to stay agile, respond rapidly to market signals and continue to push the boundaries for even greater operational excellence and we are doing just that.
In early April, We announced plans to take a combination of decisive actions to align our operations with current and forecasted demand We continue to target labor cost reductions of about job eliminations as well as temporary reductions in salaries and furloughs. Hiring and promotions are on hold, and we have cut overhead costs by reducing and eliminating discretionary spending, minimizing capital expenditures, reducing benefits and more. We have more work to do, particularly in some countries where processes for restructuring simplify and streamline processes to enable and leverage our strong and talented team. I can assure you that as painful as it is for us to lose team members, we will right size our company to ensure that we continue to deliver strong shareholder value. Sales in our second quarter were $379,000,000 down 38% year over year.
Adjusted diluted EPS was $0.08 compared to $0.94 the second quarter of 2019. We delivered 2nd quarter operating adjusted operating income of $19,500,000 with a margin of 5.1% compared to 18.9% in Q2 twenty nineteen. Now let me turn to our 3 primary markets. Commercial Aerospace build rates have declined rapidly in response to the COVID-nineteen pandemic and sales were correspondingly lower across all programs with the Airbus A350 representing the largest revenue drop. In addition, significant inventory reductions in the supply chain contributed to the decrease in sales In other commercial aerospace, we saw a 25% year over year decline in revenue.
As mentioned in our news release last night, one of the most impacted areas as a result of the supply chain correction has been on the demand for our carbon fiber. As a result, we have temporarily idled a large part of our capacity to match build rates and reductions in demand. We are communicating regularly with our customers and remained aligned and flexible to meet their expected production and supply chain requirements. For Space And Defense, lower demand in a number of international programs contributed to a modest sales drop. If we look only at U.
S. Space And Defense, sales were up slightly. Our position in Space And Defense have been growing. Especially with our acquisition of ARC Technologies. Current indications are that key defense spending will continue at current levels and we remain optimistic for this sector.
Wind Energy sales are the largest submarket in industrial and sales declined 13.6% year over year. The decline can be attributed primarily due to production disruptions in Q1 that extended into the second continued challenges, not only resulting from this pandemic, but also from increased cost pressures in the wind energy industry in general, and specifically for wind turbine blades. As we look forward, we remain optimistic and are viewing this pandemic as a unique opportunity to reevaluate everything we do to ensure that we are focused on the things that matter the most and will support our recovery. Those include maintaining our strong customer relationships, investing in innovation driving operational excellence and creating long term last few months, nothing has changed about who we are at Hexcel. We're a world leader in advanced composite technology.
Even in the face of lower demand and softer sales we remain a key technology supplier to our customers with whom we share strong and collaborative relationships Our near term objectives are clear. Staying agile and vigilant with a sharp focus on taking decisive actions today that prepares for a strong recovery and sustainable future growth. On the innovation front, our RMT teams continue to focus on new products and new formulations, especially for next generation aircraft. This work helps to solve our customers that will position us for even greater and advanced composite technology, it also is an opportunity to closely examine our entire supply chain to drive efficiency and optimize inventory levels to generate cash all of these actions will strengthen our foundation and better prepare us to take advantage of We further strengthened our balance sheet during the second quarter of 2020, increasing liquidity by $53,000,000 while realigning our cost structure and global headcount. Generate cash and staying close to our customers to Now I'll turn it over to Patrick to provide more details on the numbers.
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 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, but our costs also translate lower leading to a net benefit to our margin. Accordingly, a strong dollar is favorable to our financial results We head to this currency exposure over a 10 quarter horizon to protect operating income.
Quarterly sales totaled $378,700,000. The significant year over year sales decrease was due to rapid production rate decreases by our customers in response to the pandemic, which was magnified by destocking across our product lines. Turning to our 3 markets. Commercial Aerospace represented approximately 54% of total second quarter sales. This is a significant shift as historically commercial aerospace has represented close to 70 percent of our total revenue.
Commercial Aerospace sales of $203,900,000 decreased 51.5% compared to the second quarter of 2019. We were expecting a steep line following substantial production cuts by our customers combined with destocking of channel inventory. Also sales to the Boeing 737 Max platform was substantially lower year over year. The low rate 7 37 MAX production resumption during the second quarter only led to minimal sales as a result of the high volume of inventory in the supply chain. We expect channel destocking across the major aerospace programs continue beyond the second quarter of 2020.
This is impacting our entire product range including prepregs and direct carbon fiber sales. Carbon prepregs represent the most significant portion of our composites business. And as a reminder, those prepregs are carbon fiber impregnated with one of our proprietary resin formulations. We also sell carbon fiber directly to others who then process it into parts. Destocking of carbon fiber has been significant.
Suggesting a high level of inventory in the channel. Although painful in the near term this one time supply chain realignment will ultimately establish a support sustainable growth in the future. Space And Defense represented 29% of sales and for the second quarter totaled $108,400,000, a decrease of 3.6% compared to the same period as the U. S. Spacing defense sales increased nominally year over year.
We are experiencing near term disruptions with and supply chain from the pandemic. So overall, we remain bullish on our Space And Defense business, tempered of course by the continuing impact of the pandemic. Industrial comprised 17% of 2nd quarter sales Industrial sales totaled $66,400,000, decreasing 16.6% with weakness across the many different submarkets within our industrial space, including wind energy, automotive, and recreation primarily due to the pandemic. Turbine manufacturers to make their blades in house. We are beginning to witness greater outsourcing of the manufacturer of complete wind blades as cost pressures increase in the wind industry and we expect this outsourcing to continue.
Wind Energy remains the largest submarket within industrial comprising more than 60% of industrial sales. On a consolidated basis, gross margin for the 2nd quarter was 14.5%. Compared to 27.7 and mix Additionally, cost realignment actions continued during the quarter and further restructuring efforts ongoing as our manufacturing plants with the benefits taking a number of months to be fully realized. Selling, general and administrative expenses decreased 38.7 percent in constant currency. As we reduced headcount and tightly controlled discretionary spending.
Note that headcount reductions in this area initiated throughout the quarter and are continuing. Research and technology expenses decreased 19.2 percent in constant currency as we reduced costs across the business. Keep in mind that Hexcel is an advanced material science company focused on innovation, R And T drives this innovation. So our cost realignment at are the most selective in research and technology. The other expense category consists principally of severance costs predominantly in the U S.
We will be incurring additional severance costs in the upcoming periods for further labor reduction actions being developed, some of which have already been initiated. Adjusted operating income totaled $19,500,000 or 5.1 percent This decline in margin reflects the rapid decrease in sales, a business mix impact related to lower sales of carbon fiber, and the lag effect of cost reduction actions. Total depreciation expense increased $900,000 as we tightly managed all capital expenditures. The year over year impact of exchange rates was unfavorable by approximately 40 basis points. On operating margins.
While we have withdrawn financial guidance due to the pandemic uncertainties, based on early conversations with our customers and our visibility of inventory in the supply chain at the time, we previous Lee communicated our belief that we would be able to deliver double digit operating margins on an annualized basis throughout the cycle. Now that we have better visibility of the supply chain and more clarity from our customers, we recognize achieving that level of margin in 2020 is going to be challenging. Yet we remain determined to drive our cost actions strongly and work aggressively to maximize that there is more carbon fiber and completed parts in the channel than we previously had visibility to which is leading to a greater has a significant mix impact on our overall margins. Additionally, the production recovery for the 7 37 MAX is expected to be lower The Composite Materials segment represented 81 percent of total sales, which is consistent with historical patterns. The operating income margin was 6.3% for the second quarter of 2020 as compared to 22.1% margin in the prior year period.
The Engineered Products segment, which is comprised of our Structures And Engineered Core Businesses, represented 19% of total sales and generated a negative 1% operating margin compared to 13% in the second quarter of 2019. Engineered products was hit particularly hard by the Max situation as well as the general pandemic impact. As a reminder, engineered products requires a much lower level of investment than composite materials and under normal market conditions generates attractive returns on invested capital. The adjusted effective tax rate for the 6 month period ended June 30, 2020 was 21.9%. The expected effective Net cash provided by operating activities was $65,000,000 for the second quarter of 2020 and $73,600,000 year to date.
Working capital was a source of cash of $43,000,000 in the quarter. We expect to continue to generate cash from working capital during the second half of twenty twenty. Capital expenditures on an accrual basis were $11,500,000 in the second quarter of 2020 compared to $50,100,000 for the comparable period Free cash flow for the second quarter of 2020 was $51,800,000 compared to $73,100,000 for the comparable prior year period. Free cash flow generation in the second half of the year as we manage inventory levels and maintain our strong receivable collections. Our share repurchase program remains temporarily suspended, so we did not buy back any shares during the second quarter.
Our board will continue to evaluate share repurchases as well as the resumption of quarterly dividend payments. We further strengthened our balance sheet as 2020 compared to March 20 was $689,000,000 consisting of $257,000,000 of cash and $432,000,000 of undrawn revolver availability. Hexcel has an investment grade credit rating, which reinforces the belief in our balance sheet strength. We have no near term debt maturities. Our $1,000,000,000 revolver matures in 2024 and our 2 senior debt notes mature in 20252027, respectively.
When markets are predictable, we operate with a minimal cash balance as our business generates cash Late in first quarter of 2020, we proactively withdrew $250,000,000 from the revolver. Due to the pandemic uncertainties. Based on the confidence we now have with continued cash generation and the financial strength of our bank's indicates we repaid $125,000,000 of the revolver balance in June. Our leverage is measured on a gross debt basis and was 2.8x at June 30, 2020 compared to 2.5x at March 31, 2020. We remain well within covenant conditions.
In closing, we continue to drive cost alignment, protect the balance sheet and cash generation. With that, let me turn the call back to Nick.
Thanks Patrick. Before we open the lines for questions, I want to take a moment to recognize our Hexcel team. The past few months have been extraordinary, yet our dedicated workforce has stayed focused and safe while meeting our customer commitments. We've redefined our processes to include extra precautions, maintaining social distancing utilizing enhanced personal protective equipment many have taken pay cuts or furloughs. It has been difficult to say the least, but the team remains strongly committed and determined to deliver a great future for Hexcel.
Throughout it all, our team has stepped up in remarkable ways. For example, our plants have produced and donated hand sanitizer throughout the U S. And Europe. We shipped part of our own inventory of respirator masks to suppliers in need and we donated masks spills in some of the hardest hit areas in the U. S.
Throughout all the uncertainty and fear, our current safety performance is tracking better than last year. I couldn't be prouder of the resilience that our team shows every day even during these challenging times. The Hexcel leadership team and I continue to strengthen inclusion and expand our diversity initiatives throughout the organization. One of our core values is something we call 1 Hexcel. And it means that we have a common purpose and that we support one another in achieving that purpose regardless of who we are or where we work in our role within Hexcel.
We excel on the contributions each individual brings to our company as we strive to embody an inclusive and diverse culture consistent position is unchanged. We understand that the aerospace And Industrial Industries will take time to recover and they will recover. Question is an if or rather how soon. People will fly again both domestically first and then Internationally and airlines will once again order new high performance composite rich aircraft to meet growing demand. The trend for integrating our strong lightweight materials in next generation aircraft and industrial products remains strong.
Our focus is on preparing now so that we are ready. We recognize that the road ahead of us is a long uphill climb. I can assure you that Hexall is up to the challenge. Our commitment to operational excellence is unwavering and its impact on cost savings and productivity has never been more critical. The drive toward continuous improvement processes and perfect quality becomes even greater as we operate with fewer resources.
When the crisis passes, no company will be better positioned to support its customers in Hexcel. With leading technology, leverage by our passion for innovation, strong customer relationships that will grow even stronger during these challenging times, and a talented, resilient team that perseveres in the face of any challenge. I'm confident that our business will thrive in the future. Julian, we'll now turn it over to you and take questions.
Thank you. Your first question comes from Gautam Khanna from Cowen. Your line is open.
Thanks. Good morning guys.
Good morning.
Maybe gentlemen for both of you, I
guess, just on the channel inventory. You mentioned it might take a number. I think you said quarters, plural, but I wanted to make sure, how much of the destock do you think you fell to in Q2 and any sense for how much longer we should expect it. And on which programs, if you can identify them, the inventory overhang is greatest.
So I'll take a shot to start with. And again, if you look at the destocking, it's pretty much directionally related to the percentage of the build rate reductions across the platforms. And The impact to Hexcel is clearly going to be greatest for those programs where, we had high build rates that have come down significantly and high ships at content. And you guys see the map with the A350 being clearly one of the biggest. 7 37 MAX obviously has had some inventory correction been happening throughout the year, even in Q1, based on what was going on.
In Q2, We really started seeing the magnitude of the commercial aerospace reductions across the board. And it's our belief going to continue very strong into Q3. We're hopeful that it'll subside, but again, it's going to be very dependent on where the OEs ultimately land on 2021 production rates, which, as you know, are still being discussed and evaluated based on revenue passenger travel. So we're keeping a close eye on it. We have good visibility.
We're getting better visibility. We're working very closely with our customers, to understand what's in their supply chain and throughout So, Gautam, that's kind of where we are. We certainly see an extension into Q3.
And maybe just any specific comments on
the 87 program where it's a more gradual decline in production rate. Than what we're seeing on the 350 and some of the other platforms. Are you seeing customers starting to get ahead of that? Empty stock more dramatically than the, more gradual decline we're seeing in that program?
Thank you. I would say nothing really jumped out abnormal. It's kind of along the lines of the production rate. So we haven't seen a major surge of 87 inventory come out in a slog and we expect that to gradually work through the pipeline.
Thank you very much guys.
Thank you, Gautam.
Your next question comes from Robert Fingharn from Credit Suisse. Your line is open.
Yes, hi, good morning. Just following up on what Gautam was just saying though, we've heard some other suppliers say on the 87 that they're calibrating to 10, but of course, they're going to have to calibrate to 7, probably a year from now. And so when you factor in the destocking and continued decline, it sounds like that's one program that could be a lingering source of pressure. Is that fair?
Yes, I think that is fair. Going from 14 to 7, it's not only the build rate defense dependent, but When you're at a rate of 14, buffer stocks are much bigger than they're required when you're running at a rate of 7. So it's rightsizing to that build rate, rightsizing buffer stock. And until we get to a run rate at the seven number, if that's the the final number. There'll be continued squeezing of that supply chain, Robert.
Yes. And Nick, on that, to what extent have the major customers, so I'm thinking Airbus and Boeing, to what extent are they looking at and thresholds are to maintain a safe, secure supply chain. They talk about it all the time. But is that a real conversation that's actually happening? What are the minimums that you can produce at?
Because to some extent, we look at the balance between returning aircraft, from the desert versus new aircraft, to some extent, it's what do you want to plug into the capacity? How many new aircraft do we need versus old aircraft and then factoring the health of the supply chain?
Yes. A couple of comments. I mean, historically, we've seen that the longer planes are idled and sitting out, but less likely they are to get pulled back into production. Having said that, shifting, we were talking basically daily with Boeing, Airbus, and virtually all of our customers to stay aligned with them. I would have to tell you with Boeing And Airbus, specifically, we have not had the question on what is our minimum, production level to be sustainable simply because of a strength of our balance sheet the flexibility we have, the responsiveness we've taken and taken cost out, and just how critical we are to both their operations.
So we're very aligned. I think they have confidence in us. I think they've seen that we work hand in hand with them to help them get through their troubled times. And that's what we're continuing to do today.
Your next question comes from Richard Safran from Seaport Global. Your line is open.
Thanks. Good morning, Nick, Patrick and Kurt. How are you?
Good morning, Rich. Good morning.
So, I wanted to just first ask you a question about R&D thinking a bit strategically So R and D was down. You're clearly part of your cost controls. You state that. At the same time though, you're looking to move into some new defense markets. And I thought you might comment on what the right balance of R and D should look like when current markets are in decline, but you're also looking to expand into new markets.
Yes. Great question and great timing since last week, we had our global team for 3 days of strategic plan reviews. We do that every year and it's the precursor to get ready for our board strategic plan reviews in September. The only difference this year, they were done virtually, and I have to say with the technology, we really had productive discussions. Having said that, we focus and we live on technology and partnering with our customers to work on new opportunities Space And Defense have quite a few new opportunities in unmanned flight, electric vehicles, drones.
Other, what we would look at is maybe a little more niche applications with many more suppliers but there's a lot of activity in that area. And we're prioritizing that and we're working in, allocating our resources accordingly in that space. I wouldn't, I don't want to send the message that, we're only focused on Space And Defense. We have opportunities in commercial Aerospace on some new initiatives with new technology in lower risk areas where we can displace older technology. And those are being emphasized and refocused and prioritized.
And then in the Industrial segment, where you tend to have the ability to drive demand a little quicker. The life cycles aren't quite as long. That's another area where we're targeting some specific investment and allocation of resources. So R and T is a huge element. We spent a lot of time continuing to look at that we're deferring or we're putting on the back burner for the time being, make sure we're really supporting our customers on what they need near term and midterm.
Thanks.
Just switching to free cash flow for a minute because I thought that was the bright spot in the quarter. Cash flow looked pretty good excluding that $20,000,000 payment. So I wanted to know if you could expand on Patrick's opening remarks and discuss more about that second half, how it looks for, just more specifically in terms of inventories, receivables and payables, Should we expect working capital to be comparable source of cash in both Q3 and Q4 or is it more of the bulk of it in Q3?
Well, let me start and Patrick may want to chime in here, but, clearly, the push in the organization is to right size our inventory with the new demand levels and new production levels. And I believe we believe we're seen we've reviewed during our strategic review that there is plenty of opportunity throughout our supply chain, including raw material aerials, work in process and even some finished goods. As we took such quick actions on the cost and restructuring and the organizational restructuring. There's some inventory that unfortunately is on the water. It's in the pipeline.
It's being delivered and it takes a little time to slow that down. So we fully see the second half of the year being a source from working capital. And quite honestly, it's a big priority and especially around inventory.
Yes. The only thing I would add sort of to just to echo Nick really, we took the pain on the payables in Q2. So taking that very quickly to reflect the lower receipts of materials, raw materials coming in. Receivables, obviously a bit of AA saw that came down are at least cash. I mean, ultimately, we want to grow revenue again and turn that around.
So we've probably had a lot of that benefit But it really is inventory. As Nick said, we have a huge opportunity and the second half of the year should be stronger than what we've seen year to date.
Your next question comes from Sheila Kahyaoglu from Jefferies. Your line is open. Patrick, you talked about double digit margins being hard to achieve for 2020 versus your previous expectations. Clearly, mix is a big impact with carbon fiber. Can you talk about the trajectory of this and how we should expect that to improve?
Well, I'm not going to get into specific numbers, but clearly, with greater insight and you can't have perfect visibility upfront, but I think the magnitude of the impact from our customers and the market dynamics were stronger than we initially expected And yes, the volumes in the supply chain were larger, the destocking. And so we are going to push as hard as we can in 2020. But clearly, the double digit is going to be a huge challenge. As we go forward, we're going to drive ourselves back into double digits And we should actually see very strong incrementals once we get the top line growth. Now clearly the uncertainty is around that top line But once that emerges with all the cost alignment, the rightsizing that we're doing, we're putting in the right foundation, we'll be in a very strong position to not only getting to low double digits, but push ourselves back up to levels we saw previously.
And just on the mix impact a little bit more given obviously why bodies have more carbon fiber? Is that where we should be looking to see the growth start up? And that's where we could see margins improving?
I mean, we provide carbon fiber broadly across the spectrum of programs I mean, yes, the A350 is clearly the largest single program and that has an impact, but the narrow bodies through the engines, through the nacelles, the casings and secondary structure prepreg also pull carbon fiber. So generally as we see the carbon fiber prepreg, pull again on the way back up, that will drive strong incremental margins. That mix hurt us on the way down and it will help us significantly on the way back up.
Your next question comes from Myles Walton from UBS.
Good morning, gentlemen. This is Lou with Federal on for Myles. I just wanted to go back to, I know, Patrick, you mentioned that you the first quarter you were essentially shut down the max. You did restart in 2Q. So can you confirm are you producing?
Because you had some peers out there who basis said they're not shipping anything on the MAX until at some point next year?
No. What I will say is we're shipping at low levels It is still pretty low levels, but we are shipping small quantities of material.
Okay. And then also you've talked in the past about the fungibility, I guess, specifically, I think, of the carbon fiber. Have you had any, let's say, worthwhile conversations with customers, whether they'd be industrial or anywhere else, or is it sort of considered to shut down a large part of it? So just curious how those central conversation is gone?
Yes. I mean, a lot of our assets are fungible, but it takes time. So we absolutely are having conversations with customers about industrial applications for our carbon fiber applications for our pre preg and other sources where we can get some short term wins. It doesn't happen overnight, but we can redirect our the vast majority of our composite sort of sector segment lines and we will do that. We're not going to chase commodity low margin with no value add.
We're still going to stick to our print We want to provide some value. We may be a little bit more flexible around that. But if we can bring in some industrial recreation, automotive applications that utilize some of our carbon fiber for respectable margins. We're definitely going to do that and various conversations are taking place.
Your next question comes from Bill Gibbs from KeyBanc Capital.
Thanks very much. Good morning. Good morning. Good morning. The labor reductions targeted to be about 30% on the cost side, how much of that do you think you got in the 2nd quarter and how is the rest going to be phased in?
Yeah. I mean, I think we called out. I mean, in total cost, in pure cost, we were probably very close to sort of 25%, 30%. We're in that range. These things do take time.
We called out the 1600 heads, but then you combine that with furlough's and salary reductions, temporary salary reductions and benefit cuts and short time working. So as we sort of worked our way through the course and it's not flicking a line switch, we played as many of those cars as we could to improve our cost base So the permanent 1600 heads, those are clearly in place. As we indicated in the script, we're continuing to work on further permanent restructuring. Some of that takes longer because of rules and regulations in in other geographies, especially around Europe. And we will continue to push, but we'll combine that again with more furloughs and short time work in Smiles.
So I'm not going to be precise. I mean, it's hard to be exactly precise, but we've got a large chunk saving in Q2. We're going to see that again in Q3. And as we get towards the end of the year, we'll have a large portion of that done. But I would flag some of the European progress could even stretch into next year.
Okay. I appreciate that. And then how much severance cash cost should we expect over the next couple of quarters associated with these actions?
So again, I'm not going to call out a specific number. Bulk of the $13,000,000 sort of 95% of that number was really severance related this quarter, it will be less than that in the second half, but there will be further severance costs that come through.
Thank you. And then last question just on the wind energy market. Can you talk a little bit about these, these outsourcing issues and how how that impacts you in the short run and long run? Seems like a new revelation just trying to understand it.
Yes. I mean, what we're starting to see, I mean, the energy market is highly competitive. The price of oil is obviously sort of increasing that pressure. Wind Energy is trying to compete. And we've seen this sort of emerge over some time, but perhaps it getting even stronger now that the wind energy manufacturers are just having to really push and focus on cost and they're doing everything they can and we're seeing an increasing shift to these outsourced blades.
And so really we're just flagging that that market is going to have increasing challenges, as we see it going forward. We're going to try to be as competitive as we can, as always, drive our efficiencies, but we do see that market and cost pressures continuing.
Your next question comes from Noah Poponak from Goldman Sachs. Your line is open.
Hi, good morning, everyone.
Good morning, Noah.
Good morning. The, the release states that, you're going to temporarily suspend some operations at a few sites during the third quarter. And I think it states doing that to align production and inventory So I read that reads as, incrementally more inventory destocking in the third quarter versus second quarter. So I have that correct or is it a similar rate of that action in 3Q versus 2Q?
So, I would say a couple of things. Destocking and idling assets within our plants. We've been doing that, going back into, the end of March, April time frame based on customer, customer demand and where it made the most sense for us to allocate the resources to. What we're really pointed out in the earnings release is the carbon fiber assets that were idling, are above and beyond what we had idled earlier in the quarter. And that's going to continue along with seasonality that we typically see in Europe in the third quarter timeframe.
So we do see significant pressure and expect more destocking in the third quarter
Okay. Yes. So with your normal seasonality, if the year over year rate of decline in aerospace revenues was the same in the 3rd quarter as the 2nd quarter. The absolute dollars would be a bit lower from that. Should I think about
I don't think so. I think we've made a fair adjustment in the second quarter. We moved quickly Patrick may want to add some color there, but I don't see a dramatic change.
Okay. I think the magnitude of the underlying decline is probably similar. I mean, plus or minus but then you need to layer on seasonality. So that's the difference as Nick said that we would make probably.
Right. So it would be down year over year rough give or take roughly the same amount, but and then that would make it down a little bit sequentially.
Yeah. You could say that.
Yeah. Directionally. The items that made the Space And Defense segment growth rate negative in the quarter, are those items that last for a few quarters moving forward or was that pretty 1 quarter timing specific?
Hard to be precise on that, Noah. I mean, fundamentally, we remain optimistic and I think we used the word bullish. Around facing defense. We see that market sector holding up for us. The
U.
S. In particular is remaining strong. The softness was in Europe Some of it was pandemic. Some of it's going to be budgetary pressures. But overall, I think we really see it as timing fundamentally, the build rates in space and defense, we don't see a shifting or coming down.
So there may be a bit of a bump from quarter quarter this year, maybe a little bit noisy, but we still see the overall performance this year to be robust. And so as I say, we remain optimistic. So I don't think I would point to anything specific in Europe or elsewhere. And if anything, we see robustness in the U. S, which is very encouraging.
And medium term, a lot of new programs, which Nick alluded to, I think, on the question.
Got it. And just last one for me, Patrick, on the margin question. If I gave you the hypothetical that Boeing And Airbus did not need to cut production rates further anymore from all of this, they were able to hold what they've announced so far. In that hypothetical, would you be able to get the operating margin back into the double digits in 2021?
Our objective is definitely to drive ourselves to that. I think your question is a little bit specific, even if hypothetical. But given some top line certainty and some top line growth, we will align our costs to drive to double digits and keep going up, yes.
Your next question comes from John McNulty from BMO Capital Markets. Your line is open.
Maybe just one last question on the cash flow side. So normally second half is 70% to 80% or so of your free cash in any given year. I know this is is a pretty extreme year, so certainly not normal. But I guess, is that would that be a relatively decent metric to think about in terms of, in terms of the rest of the year's cash flow, figuring that you're going to have incremental you're going to have more the inventory help, you're going to have maybe a little bit less on the earnings help. How should we think about that?
I think directionally you're in the right space. I mean, Q2, we were able to drive some what we felt was very good cash numbers. Obviously, we don't have the top line EBITDA is under pressure. But yes, we have a lot of opportunity with inventory and the second half of the year, will be a lot stronger than the first half of the year. Yeah.
Great. Thanks for the color.
Your next question comes from Paretosh Mitra from Berenberg. Your line is open.
Thank you. Good morning, Nick, Patrick, and Kurt. So, just wanted to go back to those new revenue opportunities that you're exploring for your products for carbon fiber opportunities outside commercial aerospace? There, are you looking to gain market share from another composite producer, some competitor or these are currently applications, which are basically metal based, some other material where you're just looking to grow the use of composites Like is it more a substitution story or market share gain story?
I'd say it's predominantly new opportunities, new applications requiring new materials. Some of that may be displacement of fire metals or others, but some of the drones, some of the new unmanned vehicles, some of the technical opportunities we're seeing in industrial are for new models, new innovative solutions going forward. So predominantly new opportunities, although there are some areas where we have enhanced technology, from a cost an overall performance standpoint that we do think has some opportunity to displace existing materials.
Thanks. And maybe just a follow-up on the FX impact. Just wondering if you have tried to quantify what kind of headwind on operating margins you might see in Q3 from FX based on current exchange rates?
I mean, I think we called out about 40, 30, 40 basis points, year to date. I don't expect it to be can be different in the second half of the year. It will be a continued headwind just based on the hedges we have in place versus 2019. But I don't see it becoming significant.
Thank you.
Your next question comes from Pete Skibitski from Alembic Global Advisors. Your line is open.
Hey, good morning guys. Guys, I think it was on the last call you talked about in Engineered Products. Some of the less complex work at the Kent Washington site kind migrating to lower cost suppliers. And obviously, we kind of saw sales down pretty sharply in 2Q there within that segment. So just trying to understand how much of that was the impact of that work migrating to other suppliers versus how much was underlying market softness.
Yes. And so that's we flagged it up because that agreement that movement in the market. So as you say, the lower cost supplies is going to take place Most of what we saw to be honest in the second quarter was pandemic and general build rate. If anything, what that's going to do is soften that transition from a headline revenue perspective in that we've seen a large reduction already. And so as the under some of the underlying business comes back, we just won't get as much coming back because of that transition taking place at the same time.
So I would say largely what we've seen to date is not that transition. But the step down we saw in Engineered Product as I say, is probably going to smooth the transition whereas we expected it to perhaps be more of a step at certain points in time.
Okay, okay. I follow you. And last one for me in the industrial markets. So you've been down pretty good for 3 straight quarters now in industrial. I'm just trying to get a feel.
Obviously, my guess is you'd expect another double digit decline in the 3rd quarter. The comps easier as you head into your 4th quarter do you expect to see maybe an inflection up in the fourth quarter in industrial or maybe because of this incremental wind headwind you're going to see softness into 2021 there?
Yes, we're really avoiding given any guide simply because of all the uncertainty in the markets and the adjustments being done and just to be consistent. So We're working closely with our key customers on new opportunities. We're working closely with them on rightsizing their supply chain. So don't want to give in, get into giving any direction on what we expect to see quarter over quarter from a sales perspective.
Okay, okay. Fair enough. Thanks guys.
You bet. Thank you.
Your last question will come from Ron Epstein from Bank of America. Your line
is open.
Hey, good morning guys. Just maybe broadly, the whole caller has been a lot of focus on cost cutting and so on and so forth. From your seat, how do you know when you've cut deep enough, right? I mean, because ultimately things will turn, right? It seems reasonably dark right now, but the pandemic will pass.
There'll be some sort of fix for all this. So how do you assure that you just don't cut too far that when things do get better, you have it cut into bone as they say, probably. So how do you think about that?
So, we stay aligned for one thing. We align with our customers their programs on advanced technology for next generation airplanes, components, engines, nacelles, They may have slimmed it down with respect to what the priorities are, but they haven't stopped those initiatives nor have we. So we continue to stay very close to our customers. We continue to look at how we're allocating our challenges throughout the business, working with our team to make sure that we're not cutting into the bone. And we Patrick and I spend a large portion of our time doing just that.
And it's not only in R And T, keep in mind that some of our assets to train the skill set we need in certain assets can take up to a year. So the fact that we have fungible assets we can move around allocate and optimize our footprint and our cost structure to take into consideration customer demand but also to take into consideration, how do we maintain the appropriate level of skilled resources throughout the organization to capitalize on the growth when the growth comes back. So it's not just R and T. R and T is big, no doubt, but it's throughout the entire organization. And we monitor it real time.
If we need to cut another couple of percent or if we need to add back, a couple of percent. We adjust, daily and weak weight.
Got you. Got you. And then maybe just one quick sort of follow on. In the prepared remarks for the call, you guys mentioned that the there was more carbon fiber in the channel than you had anticipated. What was the cause for that?
Is it just your visibility is only so far? Or is it just that things have been worse for longer than maybe everybody was anticipating?
I think it's it starts with, the lead times and the complexity and the vastness of the supply chain itself. And you can look, pick a program, you might have 50 shipped to 6 you ship to's, and everybody's at a different point in delivering their piece of the puzzle, whether it's an engine fan blade or a flap or a shroud or primary structure. So the supply chain is very complex. I think our best visibility is clearly with Boeing And Airbus and what they're doing internally, less so when you start going down to the Tier 1s, even though we work with them, we don't have perfect visibility in it. And again, I would also say you've got the combination of visibility as one factor, but you also have the fact as production rates are going down, That supply chain continues to get squeezed even more.
And we've seen a combination of both.
Got you. Got you. All right. Thank you very much.
We are out of time for questions today. This will conclude today's conference call. Thank you for your participation. You may now disconnect.