Good day, ladies and gentlemen, and welcome to HEXL Corporation Second Quarter 2018 Earnings Conference Call. At this time As a reminder, this conference may be recorded. Would now like to introduce your host for today's conference, Mr. Patrick Winterland, Chief Financial Officer. Sir, you may begin.
Good morning, everyone. Welcome to Hexcel Corporation's 2nd quarter 2018 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 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 expressed permission. Your participation on this call constitutes to your consent to that request.
With me today are Nick Stanage, our Chairman, CEO and President and Kirk Goddard, our Vice President of Investor Relations. The purpose of the call is to review our second quarter 2018 results details 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. We posted a solid quarter of revenue growth earnings per share and free cash flow. With free cash flow year to For the second quarter, sales of $547,000,000 increased 10.3% year over year on a constant currency basis, with growth across all three of our Our commercial aerospace market remains strong and continues to grow based on increasing global demand for passenger airline travel. Defense budgets seemed likely to continue their upward trajectory led by the U.
S. And the world continued to adopt clean and affordable wind power which strengthens our industrial business. The combination of our strong markets and our broad portfolio of leading edge advanced composite Materials along with world class innovation positions us well for future growth and free cash flow generation. Now I'll share some insight into each of our markets and then Patrick will provide financial details for the quarter. As usual, year over year comparisons will be expressed in constant currency.
Beginning with commercial aerospace, key macro trends continue to be favorable including air passenger traffic growth and continued order flow for commercial aircraft, which support increasing production rates by our 2 largest customers airbus and Boeing. While rising oil prices have generated some concern that there may be increases in airline fares and tamper air passenger traffic growth, high oil prices have historically led to the retirement of older less fuel efficient aircraft, which then leads to demand for Our advanced composites play a leading role in making aircraft lighter and more fuel efficient. Considering that about a third of airline operating cost is fuel light weighting and fuel efficient technologies are critically important to the airlines and our customers. We continue to benefit from the ramp up of new narrow body programs, which is now gaining pace with sales for the A320neo and 7 37 Max increasing strongly in the second quarter of 2018 compared trends for commercial aircraft and together, Airbus And Boeing are reporting combined backlogs of around 13,000 aircraft. Based on public comments, there's potential upside for future narrow body rate increases beyond what has already been announced and we are well positioned strength increasing about 45% year over year, though from a low comparable in 2017.
The growth was driven by Gulf Stream, Dassault and Bombardier spread across a number of different business jet configurations. Finally, there continue to be publicized supply chain constraints in the commercial aerospace sector, particularly among suppliers for narrow bodies. Excel continues to be unaffected by these issues and we have not been asked to delay shipments for any commercial aerospace program. Turning to Space And Defense. Sales grew just over 3% year over year, driven primarily by rotorcraft demand and continued strength in the F-thirty 5 Joint Strike Fighter Program.
Strong global interest continues in the F-thirty 5 which is a growth platform for Hexcel, and we were pleased to see the recent orders for the V22 Osprey. The A400M program continued to weaken in line with expectations following previously announced production rate decreases. We are also pleased to see This will be a key growth platform for us when production begins to ramp next year. The CH53K illustrates a high composite solution, secular penetration for new space and defense platforms. In fact, almost every aspect of the CH-53K that could use composites does use them, including the airframe, blades and rotors, doors and interior panels.
Sales of Civil Helicopters in the second quarter continued their recent positive trend though they remain less than 10% of total space and defense revenue. The trend for defense spending globally continues to increase with NATO countries recently indicating a willingness to spend more. We have deep relationships with defense contractors around the world And over time, we expect this upward trend in defense spending to benefit our Space And Defense business. As expected, sales for our industrial market were up strongly driven by our wind energy business. Wind energy makes up just over half of our industrial market new generation blades using greater quantities of our materials that we manufacture in Europe, North America and Asia.
We continue to be confident Also, within our industrial market, sales for automotive and other industrial recorded growth in the quarter. In terms of our global manufacturing presence, at our new site in Roussillon France, our fully operational and aerospace qualification is underway. As a reminder, our additional fiber capacity will be used In summary, we delivered a solid quarter Results this quarter reinforce our key priorities, which include driving innovation and growth, We continue to grow sales We're driving operational excellence. We grew adjusted EPS almost 12% year over year by focusing on execution including productivity and throughput improvements and we continue to follow disciplined capital deployment. As we generate and return cash to our shareholders.
We remain optimistic for the year and we are reaffirming our 2018 financial guidance. With that, I'll turn it over to Patrick to provide
I'm going to begin with a review As a reminder, currency movements influence our reported results and some of this impacts may not be intuitive. The majority of our revenues is denominated in dollars. However, our cost base is a mix of dollars, euros and the British pounds as we have a significant manufacturing presence in Europe. As a result, when the dollar weakens against the euro and the British pound, our sales translate higher but our costs also translate higher resulting in a net headwind to our margins. Accordingly we prefer a strong dollar to a weak dollar In terms of currency hedging, we employ a disciplined hedging strategy that layers in hedges over a 10 quarter horizon.
As a result, there is a smoothing impact to currency rate fluctuations. The recent trend of moderate dollar expected currency headwind in the second half of twenty eighteen to a small degree and is now expected to be $0.04 or $0.05 headwind to EPS. A modest improvement from our estimates second quarter of 2018 were up 10.3% year over year. Our adjusted diluted EPS for the second quarter was an increase of 11.9% compared to the second quarter of 2017. Year to date, the impact of ASC 606 revenue from contracts with customers is less than $100,000 While there is the potential for fluctuations that may impact quarterly EPS by up to $0.01 or $0.02, as previously stated, we do not feel that the ongoing impact of this standard will be material to our financial statements.
Commercial Aerospace represented 70% of total 2nd quarter sales. Commercial Aerospace sales of $383,000,000 increased 9.7% compared to the second quarter of 2017. Commercial Aerospace sales particularly benefited in the quarter from increases in narrow body production rates. Increasing business jet demand was also positive although it is a smaller portion of the commercial aerospace business. Space And Defense represented 17% total second quarter sales coming in at $91,000,000, increasing 3.1% from the same period in 2017.
Growth for rotorcraft in the quarter drove the increase in sales and continued strength in the S-thirty 5 Joint Strike Fighter Program offset the A400M rate reduction. Civil Helicopters continued a recent strengthening trend though remain less than 10% of total space and defense sales. Industrial revenues comprised 13% for the quarter to 2018 sales. For the 2nd quarter industrial sales totaled $72,000,000, reflecting a 24.8 percent increase compared to the second quarter of 2017. Wind Energy drove the growth consistent with our prior guidance with the adoption that new generation blades would become apparent in our second quarter sales and would remain strong through 2018.
On a consolidated basis, gross margin for the second quarter was 26.4% as compared to 28.5 percent in the second quarter of 2017. The gross margin percentage as expected was impacted by higher depreciation expense reflecting our recent capital investments and also startup costs associated with the Rucionne France facility. Additionally, as a result of recent increases in the price of oil, we are experiencing a modest headwind related to the cost of Acrylonitrile. Which is the base raw material for our carbon fiber. I also want to mention that our wind energy business has been impacted as a result of measures taken by the Chinese authorities to reduce levels of pollution involving the temporary closure of a number of chemical plants in China including some which make the resins used in our wind energy business.
This has led to a tightening in the supply chain for these resins leading to cost pressures which we have felt in the second quarter and will continue through the remainder of 2018. Please note our long term contract include indices, which we expect to align our costs over time. Total depreciation expense increased $4,700,000 from quarter 2 2017, reflecting prior capital investments. Depreciation expense will continue trend higher in 2018. And as previously stated, the year on year increase is expected to be approximately $20,000,000.
Our focus on cost control drove a 4% reduction year over year in selling, general and administrative expenses against the backdrop of strong sales growth, thus providing positive cost leverage. Research and technology expenses increased approximately 4% year over For the second quarter, operating income increased $6,800,000 to $96,500,000 or 17.6 percent of sales as compared to $89,700,000 or 18.3 percent of sales for the second quarter in 2017. The year over year impact of exchange rates was effectively neutral due to our hedging currency hedging program. The Composite Materials segment represented 81.4 percent of total sales and generated a 20 percent operating income margin for the second quarter of 2018 as compared to a 22.3% margin in the prior year period. The Engineered Products segment, which comprised of our Structures And Engineered Core Businesses, represented 18.6 percent of total sales for the second quarter.
Engineered products generated a 15.6 percent operating income margin for the second quarter of 2018 as compared to a 12.9% margin in the second quarter of 2017. Year to date, the operating margin for Engineered Products is 13.1%, returning to the 12% to 14% range, we typically expect to see following the 1st quarters below average margin percentage for this segment. While margins are lower than composite materials segment, Engineered Products requires a much lower level of investment, which yields a very attractive return on invested capital. The effective tax rate for the second quarter of 2018 was 22.8 percent This effective rate was favorably impacted by a discrete benefit and an adjustment related to share based compensation. We continue to forecast the underlying effective tax rate to be 25 percent for the second half of twenty eighteen Free cash flow for the quarter was $52,000,000 compared to $44,000,000 for the prior year quarter and totals $55,000,000 year to date compared to $13,000,000 for the first half of twenty seventeen.
Working capital is expected to be a source of cash during the second half of twenty eighteen. We typically expect to see stronger free cash flow in the second half $4,000,000 for the 2nd quarter on an accrual basis, in comparison capital expenditures in the second quarter of 2017 were $77,000,000. Year to date capital expenditures are in line with our 2018 financial guidance. We repurchased $151,000,000 common stock during the second quarter, bringing our year to date repurchases to $181,000,000 and we have 560 $2,000,000 remaining under our share repurchase program. Pleased from an engineering standpoint while the continued startup and qualification of this facility resulted in incremental in the first half of twenty eighteen, we expect it to be relatively cost neutral for the second half of the year and to begin contributing margin as we enter 2019.
I will conclude by discussing the guidance that we reiterated in the earnings release issued yesterday. As we now look forward to the second half of twenty eighteen, we believe our revenue guidance for the year of $2,100,000,000 to $2,200,000,000 is appropriate with the potential to be above the midpoint of the range due to modestly stronger space in defense sales than previously forecast. The Airbus A320neo and Boeing 737 Max narrowbody programs are key growth drivers as both contain higher competent content than the legacy programs they are replacing and as narrow body build rates increase. Our production continues to be based on the Airbus A350 ramping to 10 planes per month by the end of 2018 and the Boeing 787 moving to 14 planes per month early in 2019. Other commercial aerospace has grown strongly year over year as forecast.
Key defense programs such the JSF and V22 are strong and general growth in defense markets across multiple programs is more than overcoming the announced Airbus A400M rate reductions. As previously forecast wind energy sales are up double digits and we expect continued strength for the rest the year. For 2018, we expect EPS of $2.96 to $3.10 with an effective underlying We continue to forecast capital expenditures in the range of $170,000,000 to $190,000,000. Free cash flow is forecast to be greater than $230,000,000. I would also like to reiterate that we anticipate returning greater than 50% of our net income the shareholders through dividends and stock buyback.
With that, let me turn the call back to Nick.
Thanks, Patrick. We've posted solid financial results for the first half of the year and we remain confident for the remainder of the year to reaffirm our financial guidance. The transition deployment priorities remain unchanged and we are delivering on our commitments to our shareholders. With that, Sabrina, we'll
Our first question will come from the line of Sheila Kahyaoglu with Jefferies. Your line is now open.
Thank you. Good morning to you both. Just on coming out of Farmboro, just a lot of press surrounding the NMA. Can you maybe elaborate on potential material for the fuselage and wing and your thoughts for the investment case for composites and just applications as it regards XL?
Thanks for the question, Sheila. Lots of excitement at Farm Bureau with from what we perceive as orders exceeding expectations. Obviously, lots of moving parts on the NMA and lots of articles some questioning the market size, some questioning the design configuration. I'm not going to take a position to predict what direction Boeing will ultimately take to position the aircraft. What I can say is we continue to work with our customers, Boeing included providing materials and solutions, next generation solutions for primary structures, for secondary structures, engines and nacelles.
And again, we remain confident if and when a new plane is launched, we will get more than our fair share and it will be more composite intensive than the legacy aircrafts that are flying today.
I try I asked Patrick because I thought I'd try you Nick on the line. And then in terms of aerospace, can you just elaborate on what's going on in the other aerospace subdivision a little bit more with regards to regionals and business?
Well, again, the business jet market has been very robust as we saw last quarter. And this quarter was no different. Bombardier, Dassault Gulf Stream, very strong, specifically the G600, G500, and the Global 7000. Those were probably the 3 biggest drivers, but I'd have to say it was pretty strong across the entire segment.
And the next question will come from the line of Krishna Sinha with Vertical Search Partners. Your line is now open.
Hi, thank you. So, can you talk a little bit about the material input costs rising and your long term agreements. Can you just talk a little bit about the expected margin headwind from that and how the pricing recovery works under your long term contracts?
Okay. So, hi, Krishna. Yes, we've got the headwinds I mentioned. So, I guess just picking up your last point there, the wind energy resin is sort of directly related to the actions taken by the the Chinese authorities. It has been called out by some other sort of blade manufacturers.
It caused the tightness in the supply chain for these resins which has sort of put pressure on the price this year, which is impacting us. We do have indices in our contracts. And so as we sort of move towards the end of this year and into 2019, we will recover those movements, but it is a headwind this year. I mean, If you think that wind energy is 5% of our total sales, I don't want to overpay the headwinds, but that there is some headwind for us. The other headwinds we're seeing is, as I mentioned, oil and I know I've said this to lots of you before we buy acrylonitrile related to a polypropylene formula, which is sort of driven by oil price movements that's moved it up.
It's right at the front end of our supply chain. And in the scheme of things, is not enormous for Hexcel, but we are seeing some marginal headwinds there. Within our commercial contracts, we do have protection if we see wild swings in oil price movement. So if that were to happen, we would be able to to pass some of that impact through. The other thing I guess I would also call out just for completeness is around tariffs at the current time, we see a tariff impact on an annual basis of about $2,000,000 to $3,000,000 Now obviously that could change depending on where things move on the tariff front, but that will impact the second half of twenty eighteen that that's related for material we're bringing in from China and to some of our aluminum supplies.
That's great. And just one more follow-up on the Rucion plant. You've talked about that being instrumental in sort of the A350 ramp you've also talked about some other programs like narrow bodies and the Joint Strike Fighter going into that plant. Can you give us a timeline on when you fix that plant to hit full aero capacity utilization?
So that plant should be running on aero based qualification really from the beginning of 2019. As I think I called out, we see the sort of cost neutral as it goes through the aerospace qualification. It's making material, but going through the qualification in the second half of this year. What I would say is that plant will be primarily focused towards the A350 making the carbon fiber for that program. A little bit for, say, blade programs.
Just to sort of reaffirm, on the narrow bodies, most of the material going on to those planes engineered core and honeycomb. So it's separate from our carbon fiber facilities.
Thank you. And the next question will come from the line of Richard Safran with Buckingham Research.
Nick Patrick, Kirk. Good morning. How are you?
Good morning, Richard.
Nick, first off, I wanted to follow-up about your comments about narrow body rates, to the best you can because I recognize you're not going to get out in front of your customer would you be willing to comment on where you are with OEM discussions on higher rates? And by that, I mean, is this something where you're still just supporting study effort or are there discussions about contracting for higher rates? And, finally from your opening remarks, do I take it I think I should take it that Hexcel's current capacity and the new capacity you're investing in actually covers, for example, what Airbus has been talking about about rate 70 as well as the potential for higher rates on the MAX?
So, I'll take those starting with the narrow body obviously whether or not the narrow body rates go higher than what have already been communicated will be a function of positioning in the market space, which I know you recognize that both Airbus and Boeing are trying to position their platforms to get more than their share of the growth. It'll have to do with the backlogs, which continue to be strong and the order intake continues to be strong. And then it'll have to do with the supply chain readiness. So I can say we have been asked to look at various studies. We've done that we continue to do that.
I would also again remind you and Patrick mentioned it, but Remember, the A320neo and the 7 37 Max are in essence metal airplanes. Their legacy airplanes with new engines and new nacelles and the majority of our content are on the engines and nacelles. Which is driving our capacity requirements. And I would tell you that type of product coming out of Hexcel has a much lower capital intensity level and we can put it in place very quickly. We do not worry about rates that you brought up in the order of 70.
We could be well positioned for that when the always needed.
Okay. Thanks for that. Now, Patrick, I heard your remarks about when for the rest of 2018. And I know you're not going to be issuing a 2019 guide on this call, but I did think that you might comment generally directionally about when did nine seen. Wind has been pretty strong thus far.
You're guiding to continued strength for the rest of the year. So I thought maybe you'd comment on what how you think that might look in 2019? And also if you could comment on the adoption rate for these new blades, just wanted to know if they're still tracking to plan.
Yes. Sure. I mean, as we as I called out, 2018 is doing exactly what we expected to. We forecast it to be above the 2016 rates, which is obviously a substantial double digit step up from 2017. So we're very pleased see that and very confident through the rest of the year.
And what I would say is based on the backlog of our key customer vestors, we're confident at this point for 2019 without getting into the specifics. So yes, as we look out for the sort of 18 month period, we're feeling pretty strong right now. And in terms of adoption, as I say, I mean, the backlog at investors is at record levels. So, I have to believe the market is liking the new products that contain our materials. So, Again, that helps us to be positive.
And the next question comes from the line of David Strauss with Barclays. Your line is now open.
Thanks. Good morning, everyone. Wanted to ask about your guidance for the for space and defense. In the first quarter, you had a very good quarter, 2nd quarter, you're still showing some growth. I think the forecast for the full year had been flat.
Are you now ready to move off of that halfway through the year?
Yeah. I think we've seen the A400M come down. It didn't come down in the first quarter the way we expected. The second quarter, it's getting more aligned. And as you see, our 2nd quarter growth was much lower than the 1st quarter.
So Given the performance today, David, clearly, we think we'll be in the low single digit growth for 2018 versus our original guidance of stable or flat.
Okay. Wanted to ask about A330. So, you have a fair significant amount of content on A330 Airbus. Has moved that or is in the process of moving that down from 60, 65 a year down closer to 50. How does that is that impacting you yet?
Is that more 2019? And how does that impact your longer term 6% to 9% guidance for commercial? Thanks.
Yes. So, A330, obviously, there's a lot written about a 30 neo orders and positioning of that aircraft. We had the step down built into our forecast and it doesn't change our long term forecast of 6 to 9, David.
Where are you today on that, Nick? On A330?
We're in pretty low rates at the moment, to be honest, David. It's not a significant program for us now. Obviously, it's going to ramp through 2019 2020, but on the NEO, which I think is what you're asking about, we're still at a pretty low rate.
Okay. Thanks guys.
Thanks, David.
Thank you. And the next question comes from the line of Mike Sison with KeyBanc. Your line is now open. Hey guys,
nice start nice quarter there. Nick, you'd mentioned that you feel good about getting your fair share and potential new launches. Can you maybe talk about on a technology basis what's giving you an edge versus the competition? Are you coming up with new carbon fiber grades, resin structures? And what characteristics do you think the OEMs are really looking for in new composite strengths, lighter weight, manufacturing costs?
Maybe just to give us a quick thought there.
Yes. So I think the primary factor that gives me confidence is the breadth of our portfolio. To your point on coming up with new fiber grades that are more productive, more efficient for the applications we're working those, working material solutions that require out of autoclave or quick cure cycles. To enhance processing. We're working those.
Looking at engineered core and engine in the cell and fab blade materials. We're working at next generation materials that give us confidence that we'll retain positions we have and we'll win incremental business going forward. And then in the parts business, we continue to look at areas where it's high value, complex where we provide a value to the marketplace. So I think it's our portfolio. I think it's our positions with customers And again, it's offering and developing multiple solutions so that regardless which direction the customer ultimately decides to go, we're in a great position to get a portion of that business.
Great. And then you mentioned that there's some supply constraints in the commercial air space kind of supply chain and you haven't been affected. Any particular reason, that you haven't been asked to delay shipments? And is that normal that you that the carbon fiber composites tends to stay on track despite other areas of constraints?
Well, I think it's a function of our customer's confidence in being able to catch up. So as you know, and it's been well publicized that there are finished airplanes sitting without engines And obviously our materials are going into those airplanes to some extent and our materials are going into those engines. So I think the engine manufacturers have done a great job and my sense is that they're on the recovery path to catch up and get on schedule. So I think it's a look at the entire supply chain and the fact that the OEs understand to reduce volumes, increase volumes, reduce them into whipsaw. The supply chain is not good for anyone.
Great. Thank you.
You're welcome. Thanks, Mike.
Thank you. The next question will come from the line of John McNulty with BMO Capital Markets. Your line is now open.
Yeah, good morning. Thanks for taking my question. With regard to the Hi there. With regard to the Rucion facility, it sounds like things are kind of going as expected in terms of the cost, the ramp up and such. And it becomes kind of a neutral in the second half of the year, if I understood that, what was the headwind in the first half?
And I guess, how should we think about that reversing as we look at 2019?
Yeah. So the headwind for each of the first two quarters was $2,500,000. So $5,000,000 in total for the first half of 2018. And effectively, we're going to cover the costs and overhead in the second half. And then we should be running sort of standard margins, good fiber margins through that plant in 2019.
So, that 5,000,000 headwind essentially that we've had in 2019, 2018 should not be there in 2019 in simple terms.
Got it. Okay. And then I guess So when I think about the margin pressure that you saw a little bit year over year, in 2Q, This obviously looks like it's part of it. I guess, how would you bucket out the rest of it, whether it's raw materials or look, I mean, in some cases, I guess, the wind power business has slightly lower margin. So it could be mix as well.
I guess, how should we think about about that and modeling out the margins as we look forward?
Yes. I mean, the headwinds as we've called out, Rucion, headwinds, depreciation step up was a headwind. FX against our guidance is a headwind. In the second half of the year, I mentioned the tariffs. The wind energy resin costs relatively small part of our business, but there's some marginal headwind there.
And then as I said, we've had some marginal again. I don't want to overplay marginal headwind on Acrylonitrile for our Carbon Fiber business. So those have been the headwinds year on year that we've pulled out.
Got it. Is there a negative mix with wind being as strong as it is or is the incremental margin there maybe bigger than what we
small dilution, John. I mean, obviously, as wind grows at a lower margin, but I have to say a good return on invested capital, but at a lower margin, that because it's only 5% of sales of the total company, the dilutions there, but it's relatively small.
Got it. Great. Thanks very much for the color.
No problem, John.
Thank you. And the next question comes the line of Ron Epstein with Bank of America. Your line is now open.
At Farmboro, you discussed a little bit, thermoplastics and what you could do there. I was wondering if you could kind of maybe give us some more color on where thermoplast could be an opportunity for you guys on future generation airplanes. So when we think about 797 or A322, where are opportunities for substitution for thermoplastics that are metallics today?
Yes, Ron. So, thermoplastics, we're excited about thermoplastics from a couple of aspects. And you've obviously seen our acquisition of Oxford Performance Materials, which is additive manufacturing using a thermoplastic PEkk system with carbon filled, which we're discussing with our customers. We're getting a lot of pull for new applications, new opportunities. That's one aspect.
The other one is you probably also recall our announcement in collaboration with our Kima Our Kima is a world leader in the manufacturer of PEKK, which is a thermoplastic resin system that we are partnering with to develop pre preg solutions that can go into next generation aircraft. So the advantages of thermoplastics They can offer, faster out of autoclave manufactured for certain types of parts. I'm not a believer. It will take over all aircraft components or all composite materials, but there is a niche where it will become very attractive for clips, brackets, smaller parts, parts that possibly the customers may want to consider welding in situ welding. Where you're prevented to do that with epoxy resin systems, you can do that with thermoplastic solutions.
So we're really excited about the next generation. Again, it's going to be a relatively slow adoption But given our portfolio, we want to make sure that's part of it so that we have a full offering to support those new programs and customers.
Okay. And maybe just some 1 or 2 more follow ons along that same vein. What do you think about ceramic matrix composite? Is that an area you guys would want to go? I mean, the products you make now are used in the big blades of engines.
Ceramic matrix would be, I don't know, if you would call it the little bleeds of engines, I mean, any desire to go that direction?
Well, first thing you have to recognize is that CMCs, the manufacturing process is really quite different. So there's very little synergy with respect to factories or technologies. Now, we always love advanced materials and material solutions space. So I'm not going to say it's of no interest, but it really does not fit today into our manufacturing footprint or product offering.
Got you. And then maybe just one last question. We were talking with a large metallic materials company recently and they suggested that they would like to move into non nonmetallics, right? So, I mean, how do you think about your I mean, this is a big, big question, but how do you think about your competitive environment in that do you worry about others trying to come in and eat your lunch be it that the materials that you have right now are really kind of desirable? I mean, it seems like that's what the going for the most part, right?
I mean, how do you defend yourself?
Well, well, I think if you look at Carbon Fiber Composite Solution they stand on their own. They're lighter. I don't care how you cut it between any kind of aluminum. The density factor is lighter. So you always have a weight advantage.
The corrosion resistance is superior. Crack propagation and micro cracking is non existent. So as the composite technology continues to evolve from a manufacturing standpoint, from a processing standpoint, as our customers become more familiar with it, they're they're becoming more productive. And I think the composite material, it's hard to say you want to go back to something that's heavier versus a lighter solution.
I understand that one thing we all do, but just the metallic guy is actually getting into your market, doing non metallic meaning they see the writing on the wall, right? I mean, nobody's going to want to go backwards, right? So, do you worry about an allegheny or PCC or whoever trying to do more non italics as the industry moves away from italics?
I think if you look at or if you've ever been in our Salt Lake City site and you look at our technology and the barriers to entry, I'm not going to say they can't do it. I'm not going to say It would take them too long, but I can assure you that the reason there's only a very few players in the world that do this is because the intellectual property. And we're very protective of that. We're not giving that away. They would have to gain that.
They would have to ramp up. They would have to prove it. That is many, many years down the road. And to answer your question, I don't worry about that specifically.
Okay. Good. Thank you very much.
Thank you. And the next question will come from the line of Chris CAPsha with Loop Capital Markets. Your line is now open.
Yeah, good morning. You had a little commentary on regional jets, but my question one of my questions was around, the alliances between Airbus and Boeing with Bombardier and Embraer respectively. Traditionally, those jets have been sort of in terms of composite content have been sort of underpenetrated by the composites industry. I'm just wondering if given these new alliances, if that portends over time, the adoption of greater material on those platforms, how do you see that developing over time and over what time period do you think something like increased content on those platforms could materialize?
Yes, Chris. So you're right. There's less secular penetration in those markets, but I would tell you it's been growing. We have very good position in the business jet market and that includes positions with Embraer, which as you know, Boeing will take advantage and help drive new solutions, more rates and hopefully more composite penetration to make the aircraft more competitive. Similarly, we've got a great relationship and position with Airbus and we're optimistic about the combination with Bombardier and look forward to even more opportunities at Bombardier throughout their business jet platforms and the C Series.
Got it. And then if a different subject, maybe Nick, you could just sort of update your strategic thinking on the role of carbon fiber composites in the auto industry and how you may address that longer term opportunity? In terms of either a technology play, maybe moving into that in a bigger way. If you think it's an exciting opportunity longer term? Thanks.
So I have always said that automotive is an opportunity for us. I like the space as long as we treat it appropriately for Hexcel and that is we're looking at the applications that are sustainable, that are growth platforms and not getting into the commodity space. So clearly, we're focusing on advancing our material solutions to make them more productive so that adoption can be increased That will happen over time. We've seen nice quarter over quarter growth in our automotive space. We're working on multiple new programs to position ourselves.
But again, they're differentiated positions in special areas similar to what we did with BMW for their roof for their B pillars, working with Lamborghini and it tends to be on the high end vehicles that really drive those sustainable opportunities. So, we're investing in it. I'm excited about it. It'll continue to grow Having said that, it's not going to, in the near term, change the makeup of Hexcel and drive the business wildly over to the industrial or automotive side as a percentage of sales.
Right. Makes sense. And then just one follow-up on the qualification and ramp of the facility in France. As you're in qualification mode and presumably producing fiber. Are you currently I assume you're selling that currently into industrial market.
So the question is, did that contribute to materially to the growth in the industrial segment and or was presumably adverse mix associated with those sales. Did that affect the was that contemplated in that $5,000,000 headwind that you called out in the first half of twenty eighteen? Thanks.
As, as you mentioned, as we qualify and as we're running the lines, as you know, we have a wide portfolio of fibers we offer to various customers. So that material is used to sell into industrial markets or other markets. The qualification effort underway as you can imagine, qualifying for the A350, qualifying for LEAP Band blades, there's numerous product forms that we have to get qualified on and it just takes time for us to proceed through that. But in essence, our goal is to virtually scrap 0 amount of that fiber and feed it into the market. So that planning and those forecasts were all rolled up into our headwind that Patrick summarized earlier.
Okay. Got it. Thank you.
You're welcome.
Thank you. And the next question will come the line of Noah Poponak with Goldman Sachs. Your line is now open.
Good morning and all.
Patrick, what's the right long term incremental margin construct now? You've had the 20 5% for a while. Obviously, the first half wasn't there with some of the new moving pieces. And I guess on the one hand, you had those moving pieces. On the other hand, I guess maybe you could keep having step ups in depreciation given what's happened with CapEx.
So just curious for your latest thoughts on the moving pieces and the kind of 2 to 3 year view on your operating leverage opportunity?
Yes. Hi, Noah. I mean, the way we look at it, we're always looking to drive our margins through productivity and yield and efficiency improvements. And as you know, over the last several years, we've moved our operating income up from sort of 11%, 12% up to 17%, 18%. So we've seen significant improvement through the period.
And we're going to continue to keep trying to push that and grow that over time through the normal initiatives working with our customers driving our lines faster and continuing to push our gross margin and our operating income up. So We believe we've got revenue growth ahead that will allow us to drive that. And so we're going to continue to push.
Are you still committed to the 25%?
As I said, we're going to continue to drive our margins. We've pushed them over the years from 11 12% to 17%, 18% and that's what we're going to continue to do.
Okay. So should I interpret that as you are no longer specifically targeting 25% as a specific number?
I would say we're not going to communicate a number, but we're pushing our gross margins, our op income margins and our incremental leverage. Basically our sales we view translating that basically we start with 100% right down through the plant. So it's why we're very stingy on when we need to add people or new plants. We try to leverage that top line through the bottom line. So really to talk about a number as we're going through this growth curve.
We really don't want to put that out there, but I can assure you we're not limiting ourselves to a 25% number.
Okay. Got it. And then Patrick, on the tax rate, I was not entirely clear, I guess, because the press release pointed to the 2nd half number I guess maybe it's cleaner in my brain if you just could tell me the new full year number versus the old full year number in the guidance for the tax rate?
Well, I'm not going to tell you that number as such because we don't sort of redo our guidance. But what I would say is you've got the rate for the 1st 6 months that average, for the 2nd 6 months, use 25% and you can do the math So that's clearly going to come in as an average under 25. Okay. But the basis for the second half is still 25. But the average for the year will be lower than that now because of where we have what we've seen in the first half.
Got it. Okay. And one final one, on A350, it seems like it's the case that you're pretty close to 10 a month. And I guess it's not clear where Airbus plans to go with the rate if anywhere else. I know you've said in the past that if it were sort of 1 unit a month higher, you could fit that through, but if it were 2, 3, 4, you would need to invest for that.
Is that something you could just turn on pretty quickly once they make the decision? Or I guess, how do you plan the business around I don't know how much visibility there is into that happening?
Talk with Airbus and our customers frequently and they give us insight into what they're thinking. So to your point, if they were to increase 1, we have to have some capacity in our supply chain given that we have sole source positions. So you have to be at least a little bit long to handle surge capacity. We could manage that. If they went up 3 or 4, they're not going to do that in a 12 month period.
It would be over a period of time and we would compare that to our existing capital and capacity planning. We would compare it to our productivity improvements which we're working aggressively on to get more throughput through the existing assets. And at that point in time, we evaluate if and when we need to invest in more high cost capital required for fiber.
Thank you.
Our next question will come from the line of Robert Spingarn with Credit Suisse. Your line is now open.
Hi, good morning. Not to belabor the incremental margin question, but Nick, you just said you don't want to limit yourself 25% So does that imply that you're going to get to go higher or when at least will you hit 25% can?
So again, we're not reiterating any number. My point was we're not limiting ourselves. We continue to leverage our business, leverage our spending, making sure we invest in the appropriate R and T going forward. Clearly there's lumpiness as you've seen historically over the years and as we ramp up these new plants. So as the plants fill up, both Rucion and Morocco, as the volume continues to grow, we'll balance that against the capital investments and basically our guidance is we're going to push margins as hard as we can while positioning the business to grow as fast profitably as it can.
Yes. And I just wonder how that all balances with the fact that both A350 and 787 will hit rate in the next 12 months, let's say, And then those lines will be relatively A350, in which case do you then have the growth to leverage the incrementals once you've done all this work? At least in that business?
Your summary is spot on. Now that doesn't include an NMA getting launched and requiring a potential investment down the road or new engine derivatives and applications coming along or new wing replacements. So there's a lot of moving parts. If you just look at the today based on what's narrow bodies and new derivatives and new platforms going forward.
Right. Okay. And then on the other side of the margin question, on SG and A, you've done well there, percentage of sales. Particularly in this quarter, is Patrick, is that sustainable? Is this the way to think about overhead going forward?
I mean, it's going to be occasionally a little bit lumpy, but we're certainly going to do, and I think you will see us leverage SG and A over time continually, yes, is our revenue grows. We will manage our SG and A costs and you should see good leverage in that space. So a little bit lumpy. I'm not going to say every quarter is going to be the same, but we should be able to do that, yes.
Okay. And then just lastly on capital deployment, Obviously, the dividends up, the buyback very strong. You've already hit your target, I believe, for the year on capital deployments. So how do we think about this going forward?
So, I would clarify, we never gave a target on capital deployment other than balancing our 3 priorities. So, which we continue to do constantly looking at new opportunities, new applications, looking at M and A, bolt on acquisition opportunities to enhance our portfolio or market positions and then return to shareholders through buyback and or dividends and or both.
I guess I should focus it on the ladder there, the return to shareholders. You've already maybe you didn't have a target there, but I believe you're at least ahead of where you've been traditionally.
Yeah. So obviously this year we're probably going to comfortably exceed what we formally called out last year to return greater than 50% of net income.
And so
that was our target. We said we were going to deliver more than 50%. We didn't tie ourselves down. So Yes. So we're doing well so far.
Is Q2 a harbinger of things to come with things like the buyback?
Again, I appreciate you testing us, but we've always said we're not going to provide any guidance on how we forecast or plan and really it's as simple as we truly make this, say, every part of our everyday business and evaluating the opportunities and looking at how we optimize our capital. So we're not going to get ahead of ourselves. We'll always report it at quarter end after the fact. And that's just what we have to do to maintain flexibility going forward. Thank you.
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