Ladies and gentlemen, thank you for standing by and welcome to Hexcel Q3 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Patrick Winterlich, Chief Financial Officer. Please go ahead.

Thank you. Good morning, everyone. Welcome to Hexcel Corporation’s third 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 statement 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 variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the Company’s SEC filings and last night’s news release. A replay of this call will be available on the Investor Relations page of our website. Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be recorded or rebroadcast without our express permission. Your participation on this call constitutes your consent to that request. With me today are Nick Stanage, our Chairman, CEO and President; and Kurt Goddard, our Vice President of Investor Relations. The purpose of the call is to review our third quarter 2020 results detailed in our news release issued yesterday. Now, let me turn the call over to Nick.

Thanks, Patrick. Good morning, everyone, and thank you for joining us as we share our third quarter results. The impact of the COVID pandemic on our industry and on our company especially our commercial aerospace business becomes more evident every quarter. The results we shared in our news release last night reflect the ongoing decline in sales resulting from global quarantines, shutdowns and social distancing that will continue until the world regains its confidence in air travel again. In the meantime, we are adjusting and making decisive business decisions to position ourselves for growth on the other side of the pandemic. We are encouraged that we have seen a slow yet relatively steady increase in global passenger travel since its trough in April. We have a long way to go before we return to pre-pandemic levels and the world now must navigate a challenging winter season ahead. We expect that inventory stocking will continue to impact production levels throughout the entire supply chain and consequently we are preparing our business for channel adjustments that could take another two to three quarters to fully work through the system. Our fundamentals remain unchanged. We have leading positions on the world's largest aerospace programs with our advanced composite technology and the broadest portfolio in our industry. We continue to generate cash flow and further strengthen our balance sheet. The great job our team has done to strengthen our foundation over the past decade puts us in a strong position to weather this storm. Although we face some challenging times we know how to plan, execute and to work through them. As we mentioned our objectives during our second quarter earnings process we have reduced labor costs by roughly 30% and have eliminated more than 2,000 positions. We have idled various assets to keep…

Thank you, Nick. As a reminder the year-over-year comparisons are in constant currency. The majority of our sales are denominated in dollars. However, our cost base is a mix of dollars, Euros and British pounds as we have a significant manufacturing presence in Europe. As a result when the Dollar strengthens against the Euro and the Pounds our sales translate lower but our costs also translate lower leading to a net benefit to our margins. Accordingly a weaker dollar as we are currently facing is a headwind to our financial results. We head to this currency exposure over a 10-quarter horizon to protect our operating income. Quarterly sales totaled $286.9 million. The reduction in sales year-over-year is due to the significant and rapid production rate decreases by our customers in response to the pandemic compounded by aggressive supply chain de-stocking across our product line and you will recognize that as build rates have fallen any given level of inventory in the supply chain will now represent a greater number of months of demand. The perspective. Hexcel last experienced this level of quarterly sales a decade ago. Over the past decade aerospace composite adoption has grown markedly and Hexcel has won a significant share of the market opportunities. During this time we have expanded our intellectual property, broadened and deepened our customer relationship, grown our global manufacturing presence while simultaneously enhancing our operational excellence and significantly strengthening our balance sheet and liquidity. I share this quote to illustrate the magnitude of the current de-stocking impact and as a reminder that de-stocking will end and gradual restocking will begin when production rates rise again. Turning to our three markets; commercial aerospace represented approximately 45% of third quarter sales. Commercial aerospace sales of $128.8 million decreased 66% compared to the third quarter of…

Thanks Patrick. The effort, the responsiveness and the way our team has adapted to this unprecedented time has been nothing short of outstanding. The commitment, the energy, the passion and the continued focus on our customers has never been stronger. Our team is controlling what they know they can control and taking action to make sure we're ready for growth as it comes back. The future of aerospace is about light weighting, improved aerodynamics and sustainability and I can tell you there is nothing that addresses those needs better than Hexcel's composite solutions. We continue to invest in innovative research and technology. In August, we launched a new product in our additive manufacturing product line that integrates advanced electromagnetic performance from our ARC Technologies’ acquisition into thermal plastic 3D printed parts for commercial aerospace and defense. We're always thinking about how we can help our customers succeed and that's evident especially in this new product because it eliminates secondary processing steps which otherwise would add cost and consume more fat manufacturing time and assets. We're not taking our foot off the gas. We're staying focused on winning that next new program because our sites are on long-term growth, long-term relationships and long-term sustainable value generation for our shareholders. We're also aggressively pushing many near-term opportunities especially in areas of space, defense and industrial where we can continue to see strong pull for our advanced materials. We are a leader in advanced composite solutions that has not changed and it never will. Going forward our focus is clear to generate and tightly manage cash and further strengthen our strong balance sheet while at the same time positioning ourselves for the demand recovery ahead. We're ensuring that we're aligned with customer demand and positioning ourselves to be ready to deliver strong incremental margins. We know that we have more tough times ahead. I challenge our team to work safely and to stay aligned with customers evolving technology needs and production demands. I know that I can rely on them to deliver because of the commitment to excellence is bred into our one Hexcel culture. [indiscernible] we'll turn it over to you and now take questions.

[Operator Instructions] Our first question comes from the line of David Strauss with Barclays. Please go ahead your line is open.

Thanks. Good morning.

Morning David. Morning.

Nick, want to, I wanted to try and touch on destocking. Can you just talk, touch on the visibility you think you have today versus [three] months ago and your confidence that this kind of takes care of itself over the course of the next two or three quarters and then it would appear that you're seeing a much bigger destocking impact relative to others in the supply chain and maybe touch on what you think is different or unique about you guys as compared to others and what we're seeing there? Thanks.

Yes. Thanks David. So a couple of points first just as a reminder to everyone remember we ship our advanced materials in advance of the build by as much as six months. Our prepregs especially have to be frozen. So if you think about our 2019 commercial aerospace revenue in the $1.6 billion range and think of six months of inventory even scale it back to say 4.5 months, $600 million of inventory in the supply chain that we've shipped that is in the tier ones, twos and threes making parts along various aspects of the build cycle. If you look at that and think about reducing that by a third that kind of calibrates you on the magnitude of the supply chain adjustment required. Now what gives us confidence and what have we seen so clearly from Q2 to Q3, we continue to see and learn more about the impacts of the pandemic. We've seen and continue to learn more about travel patterns and the slow recovery for domestic and even slower recovery for international travel. Having said that we knew Q3 was going to be a big destocking quarter and we expect Q4 will be another sizable destocking quarter and it will still linger into 2021 in the first couple of quarters. Then let me remind you that rates have continued to creep down especially in the wide bodies where we have high content. So I think we have as good a line of sight as you can have in the middle of the pandemic knowing what we know today. We feel more and more confident as we're looking to right-size our business and our supply chain and our internal inventory to those levels. So David I hope that captured your, just to your question.

Yes. Thank you. I'll get back in the queue.

Our next question comes from the line of Robert Spingarn with Credit Suisse. Please go ahead. Your line is open.

Hi. Good morning. Thank you.

Good morning.

Nick, appreciating how challenging this has been and I thought your answer to David just now gave us a fair amount of color. So I want to ask clarification there and then a margin question for Patrick but does this mean that based on all the puts and takes that 128 million -- 129 million in commercial aero would bottom around Q2 next year? Is that the idea with that? And then Patrick on the decrementals in the quarter which were about 46% decremental margin historically or the last couple of years before the pandemic you peaked around 30%. Might we expect those decrementals to drop a bit going forward?

So with respect to the commercial revenue going forward we certainly see Q4 being very challenged with another material amount of destocking happening. We expect the de-stocking to trail down and carry over into next year but our belief is it won't be to the magnitude that it is as today. So I really don't want to get into predicting the bottom. I'm hopeful that we're at or near it but I really don't want to get into guidance on what our commercial aerospace sales will be in the first quarter or second quarter next year. Patrick on the margin.

Yes. Hi Rob. So in relation to the margins yes, 46% in the quarter as you know we obviously lose a lot of variable margin as our top line comes down. We have a pretty strong variable margin percentage and so as revenue comes out we lose a lot of that sort of coverage of our overhead base and that really that drives the strong incrementals. I mean if I can just sort of counter that for a second on the way back up it's going to drive very strong incrementals as we leverage our sort of overhead base especially now that we've taken out the additional cost. In terms of the 46%, I would see that as a kind of a low point. We should start to see that soften or improve whichever way you want to look at it as we go forward partly because we're kind of realizing the cost. We're taking out those costs we've talked about on an annualized basis. More of that's going to come through and hopefully as just even small increases in our hotline are going to help I'll say offset some of that detrimental impact. But I hope that kind of gives you a shape. I would see that as a kind of a low point in decrementals.

It does. Thank you.

Our next question comes from the line of Ken Herbert with Canaccord. Please go ahead. Your line is open. Ken Herbert with Canaccord, please go ahead. Your line is open.

Yes. Hi good morning Nick and Patrick.

Good morning Ken.

I wanted to follow up Patrick on the working capital. I mean you did a good job in the quarter clearly. You've called out opportunities as well in the fourth quarter to sounds like take inventory and working capital should be a source of cash. Inventory levels are still relatively high. How do we think about working capital here maybe some more specifics into the fourth quarter but then as a source of cash into the first half of ‘21 balanced against when you might need to start to just sort of restock or invest in some material again?

Yes. Thanks Ken. So working capital in the third quarter was just under $81 million as a source of cash. That was clearly a strong release of cash from working capital and you can only take it down so much relative to the overall business demand reduction. I do see further opportunities in inventory. I'm not going to call out specific numbers. Receivables are probably going to start leveling off as are payables. But I do see a working capital benefit in the fourth quarter of 2020. As we start to stabilize and level off as with so with our working capital and so there comes a point where we're going to kind of level off in terms of releasing any more from and I think that's what you were alluding to. We should see some sort of what I call stability in our working capital level as we go into 2021. Then as we kind of move into the second half of the year and we start to see a little bit of growth. Our working capital will be in a very disciplined and controlled way potentially start to grow again as you would expect.

Great. Thank you.

Our next question comes from the line of Richard Safran with Seaport Global. Please go ahead. Your line is open.

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

Good morning. Good.

So I thought one of the more interesting comments in your release was the statement about expecting, I think you said a significant upturn in 2022. I thought you might tell us where the confidence comes to make that statement. I thought you might elaborate on that a bit more. Maybe you could touch on for example which platforms you see is the major drivers in the recovery?

Okay. Richard. I'll take a shot at that. So in general it's not one thing but from our view people want to travel. People want to get out, go places, visit and as the borders open up as medical advances continue, as vaccines are released people are going to get back out travel. I believe there's a huge pent-up demand and even on the business side businesses need to get out visit customers visit sites do business. And I believe that's going to recover again as the epidemic and the understanding and the social distancing and the new processes and procedures gets confidence. So that's the big thing. Second, if I look at what we're going through today the destocking, destocking is a one-time effect. Now granted, it's layered down by program and every production cut takes more destocking but it is one time and once it's done and you're right-sized there is a tremendous upside opportunity for once the growth comes back because remember that supply chain will be very lean and our customers and the complex supply chain will be pulling and replenishing that broad supply chain. If you look at narrow body demand, we mentioned it in the script that narrow body A320 backlog, order intakes continued so that the backlog is where it was even after nine months of bill rates we're hopeful and I believe we're seeing more and more confidence that the Max will return and even though there is a large inventory in that supply chain we still expect Boeing to ramp up and get their supply chain secured and gradually increase over time. So strong narrow body backlog, strong Max pull that will happen out of inventory first and then bill rates will increase. If you look at what we've done, the actions we've taken on the restructuring, on the cost reductions, on the overhead reductions it's just going to make us even more efficient and able to leverage that growth into incremental margins. So based on what I'm seeing the pull we're seeing from our customers even during this challenging time for advanced composite materials to provide new solutions, to provide new ways to drive weight down, costs down, efficiency up, it makes me confident gives me even more confidence. And lastly recognizing wide body recovery probably will be slower than certainly the narrow body and international travel will probably lack domestic travel growth. Having said that there's a significant amount of parked aircraft that will be taken out of service and as that travel comes back the replacement of aircraft are going to be highly composite intensive newer airplanes where we have strong positions. So it's just a question of when that happens towards the end of ‘21, early ’22. I think we're in a great position to capitalize on that market.

Thank you very much. Appreciate it.

Thanks Richard.

Your next question comes from the line of Robert Stallard with Vertical. Please go ahead. Your line is open.

Thanks so much. Good morning.

Good morning, Robert.

Nick, I was wondering if you could elaborate a little more on what's been going on in the wind sector? Something I don't know a hell of a lot about actually and how much further pressure there could be on the market share situation here?

So and again as we have stated before the wind energy market is certainly very cost competitive and the cost pressures they're not new. It's the way the business has been since I've joined Hexcel. If you look at our key customer and others their ability to compete by being vertically integrated, they're no longer able to do that. So they're outsourcing various components to improve their business model and that's one of the things that's happened in the U.S. wind market, migrating to an outsourced wind turbine blade for various models and that wind turbine blade made by outsourced providers do not use a prepreg solution. They use a lower cost infusion method and lastly we've looked at our Windsor site. We looked at the cost pressures and the margin in that and it just makes no sense for us to continue in that area given our other opportunities with acceptable margins from our perspective.

So could this issue also spread to Europe and Asia as well?

So in Europe, in Austria we have a broader mix of products and the more significant portion our legacy blades with a high mix. So the likelihood of those migrating is much lower. Although there is always cost pressures there and we're working with our customer to continue to find cost reduction initiatives that we can share with that. In [indiscernible] our wind plant in China we continue to operate very well today. We continue to work with investors. It's no different. There are cost pressures there and we're closely watching that to make sure we can align with what best directions and needs are going forward. So it's a watch item for us.

That's very helpful. Thank you.

Thank you Robert.

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

Hey good morning guys. Thanks for taking the question.

Good morning, Mike.

Just in light of the destocking that's expected to continue here, how should we think and again I guess taking into context the cost out, you guys have taken out of the business how should we be thinking about the double digit margin? I mean is that still a realistic assumption for 2021 assuming we'll have some destocking pressure? Should we think about maybe exiting the back half of ‘21 with double-digit margins maybe? Just some more color there.

Yes. I mean it's a good question and our margins are going to be pressured for some time. I think it's a little bit early we're not guiding to 2021 but with the cost takeout, with the realignment we're doing, we're in the process of pulling together our sort of detailed plan and forecast for 2021 literally right now. We are still targeting sort of to push. It's probably not going to happen and I think you're alluding to in the earlier part of next year but as we moved into the second part and we continue to push we will be driving towards double digits and certainly as we go into 2022 and beyond we'll be driving back into those levels and much higher. So don't want to guide to 2021 yet but certainly double digits is a target on our horizon for next year.

Got it. Understandable. Thanks guys. Good one.

Your next question comes from the line of John McNulty with BMO Capital. Please go ahead. Your line is open.

Yes. Good morning. Thanks for taking my question. So it seems like there is kind of two destocking issues. There is the industry de-stocking and then your destocking on top of it and it sounds like by your commentary around working capital improvements where they may end at the end of the fourth quarter even though the industry destock continues for a while, it sounds like at least one of those pressures on the cost is going to kind of stop which is the pressure that your system is facing because of your own destocking. I guess how should we think about or is there a way to quantify what that pressure has been so as we look to 2021, we don't, I assume we don't face that. Is there a way to think about that?

Well, I would give you this color around that. We've been very aggressive to right size our internal supply chain to the point that we have multiple facilities assets sitting idle as we speak. Especially, in our high margin carbon fiber assets we've reduced our production to draw down our inventory, to get it right size so that we can enter the year with more assets online, our trained workforce in place and make sure we're ready for that rebound as it comes. So I really don't want to get into giving you a split on dollars of internal versus external but for Patrick's point we expect the bulk of the internal to be behind us at the end of the year and continue to drive inventory efficiencies throughput and improvement on days throughout next year.

Got it. Fair enough and maybe just one other thing too and Nick you had mentioned at the end you're kind of prepared comments a focus on look you've got a really diverse platform in terms of your composites. Are you starting to look at other opportunities that maybe in the past weren't quite profitable enough or hadn't developed enough where we could see some sizable pieces of incremental volume coming in while you're going through this what looks to be a potential multi-year downswing on the aerospace side?

Yes. It's a great question and now is the time that's quite unique from Hexcel's perspective keep in mind we've been investing significantly to increase our capacity for the build rates that were ahead of us and we had very little spare capacity to experiment with, to try to derive different products. We didn't have the capacity. Today we have that capacity so to answer your question we absolutely are looking at diversifying our capability and that goes not only in fiber assets it's throughout our internal supply chain in our products and we are looking at other opportunities and I'm not going to say they're lower margin opportunities. They're great opportunities. They may be smaller volume, more niche, more space and industrial and specialized areas but we're seeing a tremendous amount of pull from our customers for those types of applications.

Great. Thanks a lot.

Our next question comes from the line of Ron Epstein with Bank of America. Please go ahead. Your line is open.

Yes. Hey, good morning guys.

Good morning.

Does your outlook for, the destocking outlook, contemplate the possibility that we could see yet another cut in A350 and 787 given what's going on in the wide body market?

So we're staying close to our customers and as Patrick mentioned we're still building out our plan. It's not final. We're getting close to getting ready to get that buttoned up for the year and we're looking at scenarios both upside and downside and taking that into consideration. So I think it'll depend on how soon people travel, what international travel does and what the demand for wide bodies continue to do. I'm still optimistic the A350 backlog is still relatively strong and again it really is going to be driven by revenue passenger travel. So we're looking at those scenarios.

Got it and when you think about on a maybe on a go forward basis maybe from a broader strategic perspective how are you thinking about diversifying the company? Do you think you need to or not?

Well, do we think we need to change who we are. No, we love who we are. We've got great positions. We've got tremendous customer relationships. Do we need to have plans on how we deploy cash? Absolutely because we're going to be a strong, very strong cash generator and we want to drive growth through the utilization of that cash. Obviously, return to shareholders through dividends and buybacks are another avenue. But our real first priority is to figure out how to position the business for long-term sustainable growth and M&A landscape and looking at our business through a different lens is clearly on our radar as we demonstrated when we were in the midst of the Woodward acquisition and then unfortunately we had to abandon that. So I'd say we've got a pretty wide aperture on opportunities ahead of us and we continue to look at that.

But I guess what I was saying is not necessarily dramatically changing the company but just broadening your industrial exposure. I mean there is for sure given all the changes in industrial and markets other places you can apply the material science you guys do outside of aerospace?

Well, again it all comes from, it all focuses on technology. We really don't pick okay we're going to go after and target this market, this market. We focus on the technology and the high-end technologies, the things that can differentiate us that don't fall under a commoditized product scenario or can't be replaced easily and we're indifferent on whether that's in the space or industrial or wind or automotive or marine. So our focus is on advanced technical solutions that help our customers on light weighting, on durability, on processing times and getting costs out and it's across the board. So we're seeing tremendous pull in all of our markets to do that.

Great. Thank you very much.

Thank you.

Our next question comes from the line of Noah Poponak of Goldman Sachs. Please go ahead your line is open.

Hey, good morning.

Good morning.

Hey, can you guys give us a sense even if a pretty wide range of how much annualized recurring a run rate revenue you're losing to this displacement that occurred in the wind business, just so we can recalibrate that and then on the aerospace side when you quantified the inventory in the channel and destocking yet to occur, I was curious if you could specify that on the Max since that's so much different be helpful to know where you stand on that program.

So in terms of wind, I mean, I mean you could probably almost do this yourself now but I mean I guide you sort of industrial historically what 12%-13% of our sales in 2019. About half of that maybe just over was wind energy and broadly a third was related to the Americas market. So that kind of should give you a magnitude of what we're talking about I mean in the scheme of things certainly under in a normal year. It's a relatively small amount of revenue but hopefully that kind of binds it for you.

Yes. That's helpful.

Yes and with respect to your question on Max destocking that's a huge unknown, we're being fairly conservative staying very aligned with Boeing on what their scenarios look like and depending on how quickly the recertification happens and the domestic travel picks up and the delivery of the significant amount of aircraft that are already finished, we're really watching that closely but we're not going to get into program by program on what kind of destocking we are building into our forecast.

Our next question comes from the line of Sheila Kahyaoglu with Jefferies. Please go ahead, your line is open.

Hi, good morning guys and thank you for the time. Nick and Patrick, I know you're not guiding but maybe something that would help us walk through how we could think about your gross margins this quarter and the contraction. Maybe Patrick if you could buck it for us what the volume decremental was versus the mix headwind and then the idle facility cost and then of course you mentioned $150 million of annual cost savings; how much of that was in Q3 and how do we think about the cadence of that as we progress? So not looking for guidance just looking for a little bit of a bridge in the quarter just to think about how do frame that look?

Yes, so. If I start with the savings $150 million annualized savings, we've now kind of got actions and we're driving forward and we can see that as I say on an annualized basis some of that was there in Q3 probably a very limited amount was there in Q2 and that will continue to grow now into Q4 and Q1, Q2 next year as we really get it flowing through. So that's going to come off our overhead base our fixed cost base as a company. In terms of all the margins you called out there, I mean I think what you have to remember is that Hexcel drives a strong and I think I said this earlier on a strong variable margin. So if you take out top line sales, you take out a lot of margin and that clearly becomes quite a significant headwind which drives the decrementals that we've talked about and so while we continue to face these challenging top-line quarters our margins are not going to rapidly improve. We will continue to drive costs that will help marginally as the top line starts to creep up by small incremental steps that will also help marginally. So we will right-size ourselves as strongly as we can. We will position ourselves through the end of this year and going into next year. We continue to take cost action especially in Europe which takes time to really sort of play out and we'll see those benefits emerge more strongly as we go into next year but then as we start to get the top-line growth we'll drive the strong incrementals off that large variable margins that I talked about and that will really help reposition the company. So $150 million is a significant step in our structural costs. We will leverage that when we start to see some growth [back upwards].

Okay, thank you.

This concludes today's conference call. Thank you for your participation. You may now disconnect.