Title

Presentation

Hexcel Corporation beats earnings expectations. Reported EPS is $0.5, expectations were $0.38.

Operator: Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hexcel First Quarter 2023 Earnings Conference Call. All lines have been placed on mute, to prevent any background noise. After the speaker’s remarks there’ll be a question-and-answer session. . Thank you. Patrick Winterlich, Chief Financial Officer, you may begin your conference.

Patrick Winterlich: Thanks, Rob. Good morning, everyone. Welcome to Hexcel Corporation’s first quarter 2023 earnings conference call. Before beginning, let me cover the formalities. I want to remind everyone about the safe harbor provisions related to any forward-looking statements we may make during the course of this call. Certain statements contained in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the company’s SEC filings and last night’s news release.

A replay of this call will be available on the Investor Relations page of our website. Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be recorded or rebroadcast without our express permission. Your participation on this call constitutes your consent to that request. With me today are Nick Stanage, our Chairman, CEO and President; and Kurt Goddard, our Vice President of Investor Relations. The purpose of the call is to review our first quarter 2023 results detailed in our news release issued yesterday. Now let me turn the call over to Nick.

Nick Stanage: Thanks, Patrick. Good morning, everyone, and thank you for joining us today as we share our first quarter 2023 results. Our first quarter results reflect a strong recovery in demand with overall sales up 18% year-over-year, bolstered by a 30% increase in Commercial Aerospace sales. We delivered strong margin leverage on the increased production volumes, leading to a robust operating income for the fourth quarter. The strong demand for new aircraft is clear with a combined backlog for Airbus and Boeing now at roughly 12,600 aircraft. Airline orders are increasing for new, lightweight, composite-intensive planes to replace older, less fuel-efficient fleets and to meet growth in passenger demand. Indications are that domestic air travel has not stopped accelerating in recent months despite inflation, and now many expect that passenger demand could recover to 2019 levels by the end of this year as China reopens.

International air travel is also coming back strongly, including both leisure and business and is recovering more quickly than many had expected. During the first quarter of 2023 alone, there have been six different widebody orders and options announced from Asia, the Middle East and Europe, for a total of 215 widebody aircraft for Airbus and Boeing. Announced orders or options for narrowbodies, including the Airbus A320neo family, the A220 and the Boeing 737 MAX remains strong and steady at 464 aircraft in the first quarter. We remain aligned with our customers and ready to support their growing demand. We recognize though that there are broader challenges in the aerospace industry relating to supply chain constraints, labor shortages and workforce and experience, and we are staying vigilant and agile in order to provide support as required to our customers.

Yet while our optimism may be tempered by these factors, we could not be more pleased to start 2023 with such positive momentum. Our confidence is strong as we reaffirm our full year 2023 guidance that we provided in January. Now let me highlight some of the results, and Patrick will then provide more detail on the numbers. Commercial Aerospace sales of $285 million increased 30% compared to the first quarter of 2022, led by growth in the Airbus A350 and A320neo programs. Other Commercial Aerospace increased more than 23% for the first quarter on expanding business jet demand. The outlook for narrowbodies, widebodies and business jets is extremely encouraging. They are all growing and creating further demand for more Hexcel composite material.

Space & Defense sales of $126 million increased 7.6% in constant currency with growth across a number of platforms globally, including fixed-wing aircraft and both military and civilian rotorcraft. We see a period of increased space and defense spending, including Europe and Asia Pacific, which for the first quarter of 2023 represented approximately one-third of our total Space & Defense sales. Total Industrial sales of $47 million decreased about 9% in constant currency due to lower wind energy sales that were partially offset by sales growth and recreation, automotive and general industrial markets. Marine continues as an emerging growth market for us. And in fact, this week at the JEC World Trade Show in Paris, Hexcel was recognized along with one of our customers and a consortium of other partners for our work on new composite technologies for the marine sector that will eventually lead to quieter and more environmentally sustainable cruise and cargo ships.

As with every quarter, I want to thank our One Hexcel team for their focus on execution and efficiency through operational excellence, ensuring that we deliver quality products to our customers on time. The labor market remains tight and certainly the necessary talent takes longer to find. Yet we have been filling jobs both on the plant floor and in our offices with great success over the past several months as job seekers are attracted to our collaborative culture and our compelling business outlook with our sustainability-oriented light leading products. Our success as a company is not just what we do, but how we do it. Our growth position today is supported by how Hexcel managed during the downturn by quickly ramping down yet without sitting still.

A prime example of that is our decision to invest in a new research and development site adjacent to our largest carbon fiber and matrix plant in North America and Salt Lake City, Utah, which some of you have visited on previous Investor Days. We broke ground in October 2021, and then on March 22 of this year, our Center of Research and Technology Excellence officially opened. Customers from about 20 companies joined us for an event where we celebrated with local public officials and employees with everyone having the chance to tour our state-of-the-art labs and meet our researchers and scientists who now are calling this remarkable innovation center their home. With about 100,000 square feet of floor space, our new R&T center of excellence provides us with an amazing opportunity to expand our research and broaden our technology portfolio.

It is also an ideal platform for us to collaborate with our customers on the latest innovation and lightweight, sustainable solutions and the latest developments in carbon fiber and matrix technologies for aerospace Space and Defense and industrial applications. It will quickly become a showcase that demonstrates our world-leading composite technology. Lastly, as you read in our news release last night, we are reaffirming our guidance at $1.725 billion to $1.825 billion in sales for 2023 with adjusted diluted earnings per share of $1.70 to $1.90. Our guidance on free cash flow is to generate more than $140 million while continuing to manage accrued capital expenditures with approximately $90 million of sales forecasted. Now I’ll turn it over to Patrick to provide more details on the numbers.

Patrick Winterlich: Thank you, Nick. As a reminder, the majority of our sales are denominated in dollars. However, our cost base is a mix of dollars, euros and British pounds as we have a significant manufacturing presence in Europe. As a result, when the dollar strengthens against the euro and the pound, our sales translate lower while our costs also translate lower, leading to a net benefit to our margins. Conversely, a weak dollar is a headwind to our financial results. We hedge this currency exposure over a 10-quarter horizon to protect our operating income. As a result, currency changes are laid into financial results over time. As a reminder, the year-over-year sales comparisons I will provide are in constant currency, which thereby remove the foreign exchange impact to sales.

Turning to our three markets. Commercial Aerospace represented approximately 62% of total first quarter 2023 sales. First quarter Commercial Aerospace sales of $284.5 million increased 30% compared to the first quarter of 2022, led by both the Airbus A350 and A320neo programs. Airbus raised the production rate of the A350 in early 2023, which led to increased first quarter sales, including some restocking. The Other Commercial Aerospace category grew 23.5%, led by strength in business jets. I would like to highlight that our first quarter 2023 business jet sales exceeded pre-pandemic levels, which is supported by the growing secular adoption of composites for lightweighting by business jet manufacturers. Space and Defense represented 28% of first quarter sales and totalled $126.2 million, increasing 7.6% from the same period in 2022.

The growth continues to be across multiple platforms globally, including fixed-wing aircraft and both military and civilian rotorcraft, partially offset by softer space sales. Industrial comprised 10% of first quarter 2023 sales. Industrial sales totalled $47 million, decreasing 9.1% compared to the first quarter of 2022 on lower wind energy sales. As we mentioned last quarter, wind energy sales stabilized in the second half of 2022. Recreation, automotive and other general industrial sales grew year-over-year. On a consolidated basis, gross margin for the quarter was 27.9% compared to 22.3% in the first quarter of 2022. Higher production levels and robust margin leverage were the principal drivers of this strong performance. However, I want to caution that the gross margin this quarter was particularly strong for a number of reasons; sales mix was favourable with strong demand for Hexcel fiber-rich products; there was a favourable absorption impact as a result of increasing finished goods inventory; and foreign exchange was also a tailwind this quarter due to the significant dollar strength compared to the first quarter of 2022.

As a percentage of sales, selling, general and administrative expenses and R&D expenses were 14.1% in the first quarter compared to 14.2% in the first quarter of 2022. Consistent with past trends, first quarter SG&A expenses were elevated on stock-based compensation. So SG&A is expected to moderate for the remainder of the year. R&D expenses were higher on more material development costs as we pursue new opportunities with our innovative composite lightweighting solutions. Adjusted operating income in the first quarter was $63 million or 13.8% of sales compared to $31.1 million or 8% of sales in the comparable prior year period. The year-over-year impact of exchange rates in the first quarter to adjusted operating income was favourable by approximately 80 basis points.

Now turning to our two segments. The Composite Materials segment represented 83% of total sales and generated an 18.4% operating margin, strengthening year-over-year on higher sales and production volume as well as mix. The operating margin in the comparable prior year period was 12.9%. The Engineered Products segment, which is comprised of our structures and engineered core businesses, represented 17% of total sales and generated a 14.9% operating income margin as compared to 13.7% in the comparable prior year period. The effective tax rate for the first quarter of 2023 was 21.9%. Net cash used for operating activities in Q1 2023 was $23.4 million compared to a use of $19 million in the first quarter of 2022. Working capital was a use of cash of $104 million in the first quarter to support higher sales.

This working capital increase was consistent with expectations and path trends as working capital increased $74.3 million in the first quarter of 2022. Capital expenditures on an accrual basis were $16.8 million in the first quarter of 2023 compared to $11.1 million in the prior year period. As previously disclosed, 2023 capital expenditure included further construction related to the partially completed carbon fiber line at our facility at Decatur, Alabama to support future growth. Free cash flow was negative $41.5 million in the first quarter of 2023, which was similar to the negative $39.9 million in the prior year period. For an alternative metric of cash generation, adjusted EBITDA in the first quarter of 2023 was $106.6 million, up 44.6% from $73.7 million in the first quarter of 2022.

I am pleased to let you know that we have just renewed and extended the maturity date of our bank-syndicated $750 million revolver to April 2028. The terms and conditions were basically unchanged with two key revisions to highlight. First is that the borrowing base rate was revised from LIBOR to SOFR as expected. The other change is beneficial to Hexcel as the leverage covenant calculation was revised to net debt whereas, previously, it was measured on a gross debt basis. Successfully concluding this refinancing during a period of banking turmoil speaks to the financial strength of Hexcel and the support of our bank group. The Board of Directors declared a $0.125 quarterly dividend yesterday, payable to stockholders of record as of May 5 with a payment date of May 12.

We did not repurchase any common stock during the first quarter of 2023. The remaining authorization under the share repurchase program on March 31, 2023 was $217 million. As Nick stated, our full year 2023 guidance is reaffirmed. With that, let me turn the call back to Nick

Nick Stanage: Thanks, Patrick. We welcome the return to growth and ramp-up in programs. Our customer relationships have never been better, thanks in part to our flexibility, transparency and reliability. Pent-up demand for air travel is loading up seats on airplanes, which is expanding backlog for new, more fuel-efficient aircraft. And as the market recovers, Hexcel benefits from the continued penetration of lightweight composite materials as well as our never-ending commitment to innovate with our customers on new materials and solutions for next-generation programs. Supply chain issues remain a watch item for us as they do for most other suppliers in our industry. However, global demand for advanced composite technology from lighter-weight, stronger and more durable materials in all of our markets is growing.

And our technology and products remain unrivalled in our industry. The disciplined actions we have taken and our focus on execution will ensure that Hexcel continues providing long-term shareholder value. Rob that concludes our prepared remarks. We’re now ready to take questions.

Operator: Your first question comes from the line of John McNulty from BMO Capital Markets. Your line is open.

John McNulty: Yes, good morning. Thanks for taking my question. So a question regarding the maintenance of your full year guide. So your first quarter came in really strong. And it did sound like maybe there was a little bit of continued restocking of inventory, so maybe that is part of the answer. But I guess when we think about the seasonality of the business, your strength in the first quarter would imply maybe a better range for the full year. So I guess, can you help us to understand maybe some of the puts and takes there or some of your conservatism as to the full year guide and no changes there?

Nick Stanage: Yes, John. Well, thanks for the question. First off, clearly, we started the year strong, and we’re seeing improvements in many of the supply chain aspects that are creating some uncertainty and continued pressure in the industry. So for one, we’re early in the year. We just gave guidance in January and the guidance has pretty wide ranges on it. So the tweak it at this point in time, just didn’t make sense to us. Secondly, the supply chain risks not necessarily only to us but for other components that could ultimately impact build rate ramps, I can’t say those have gone away. They’re still there, and we probably are taking a conservative view on that and some of the other shortages that are driving some challenges in various areas of discrete part manufacturing within the industry. So maybe a little bit conservative, but at this point in the year, that’s really the position we want to take and convey.

John McNulty: Got it. Fair enough. And maybe just as a follow-up, your balance sheet strengthened a lot. Your leverage, if I’m looking at it right, is now below 2 times. And you actually have that maybe better covenant flexibility as well. So how should we think about cash flows and the uses as we go forward? Can we see maybe a push into buying back some stock throughout the year? Or are there opportunities on the M&A front just given your strength maybe relative to others out there where maybe that’s more attractive? I guess maybe you can give us some color around that.

Nick Stanage: Yes. So I’d say it’s unfortunately for you, maybe a boring answer, but it’s consistently what we’ve said for quite a few quarters, certainly since I’ve been talking and sharing our earnings results. First and foremost, our team are pushing innovation, new technologies, innovative new fibers, new processing, new solutions for our customers to help them not only on existing platforms and various derivatives that are being worked to prepare for the next generation of platforms. There’s also new programs out there that awards are not set yet, for example, on the Valor 280 or many military programs that we continue to work and continue to innovate. So organic growth is priority number one. Priority number two is we really look at the M&A landscape.

We look at bolt-ons. We look at our technology portfolio and how we might expand that to be able to offer our customers even broader, more value-driving solutions for their lightweight needs. And that pipeline, we’ve been looking at that continually. We’re disciplined. We’re very selective. But that’s how I look at number two. And then lastly, we always look at our balance sheet. We look at our debt ratio and we review with our Board on a regular basis our dividend strategy and our share buyback strategy. And as you see, the cash generation is ramping up as our sales grow. So I would expect we’ll continue to look at all three of those priorities. And without guiding to definitively, I’d say all of them are in play going forward.

John McNulty: Great, thanks very much for the color.

Nick Stanage: Thank you, John.

Operator: Your next question comes from the line of Rob Spingarn from Melius Research. Your line is open.

Robert Spingarn: Hi, good morning. Nick, obviously, just on the back of that last question, strong numbers here in the first quarter. And you talked about the OE on the build rates. But I wanted to get a little bit more specific and see if you could take us through your plans for the major programs, A320, A350, 737, 787, et cetera. And I’m particularly focused on the MAX because there’s talk of higher rates, but what we’re not clear on is whether some of those aircraft are mods coming out of Moses Lake. And therefore, you wouldn’t participate because you’re already — those aircraft are already largely built from a Hexcel perspective. So that’s essentially the question. What is — how do rates flow throughout the year on those programs for you?

Nick Stanage: Well, let me start with Boeing. I mean, there’s a lot of momentum and positive news coming out of Boeing. I know they had the recent issue that we’re working through with Spirit. But just before that, they’re really looking at potentially getting to a point of increasing rates from where they have been, around the low 30s. So we feel real good about the MAX. We see China continuing to issue reports that make it more comfortable for airlines to take new MAX deliveries. And we know Boeing have inventory that have been built and structured from the Chinese market, so that would be another tailwind that would help the MAX. So the aircraft, obviously, with the orders you’re seeing, the length of time it takes to get a new aircraft, there are plenty of demand for the MAX as the supply chain stabilizes and Boeing can increase rates.

So that’s the MAX. On 787 — and I would point out, even though we highlighted the A350 and the A320neo, we were up year-over-year on the MAX and the 787. We were up sequentially on both those platforms. So I don’t want to diminish the strength of Boeing, we just called out the biggest market drivers for the revenue dollars. If you look at the 787, again, it was up. It has been at low rates. We saw a nice uptick in Q1. And again, Boeing is targeting to be closer to 5% by the end of the year. So we do expect that to continue to provide strength going forward. So to the Airbus side, if you look at the A220, orders continue to come in strongly. We have a nice position there. 320neo is on a glide path to ramp up to the mid-60s by the end of next year, still targeting to be in the mid-70s by 2025-time frame.

So continued growth, strong positions we have there. And then the A350 has recently moved up to six. And Airbus has been vocal and public on targeting the ramp up to nine per month by the end of 2025. The A330neo, where again we have strong position is that per month, and we see that maintaining a consistent level going forward. So overall, we still see tailwinds on build rates. And again, we’re very bullish on the market with the caveat that the supply chain is still questionable with respect to how quickly it can ramp up and if it might impact build rates in the next 12, 24 months.

Robert Spingarn: Okay. That’s great color. So I appreciate that. Patrick, just briefly on the biz jet. I think you talked about biz jet before and have content per aircraft is up versus ’19, and that’s one of the — at least one of the reasons why you’re above ’19 levels in revenue. Is there any way to measure that what your content is as a percentage of an aircraft’s value and how that’s moved and where it’s going to move over the next couple of years? And how much confidence do you and Nick have in the biz jet production rate hikes?

Patrick Winterlich: So the way I would talk about biz jets is we saw some fantastic growth in build rates over the last couple of years, and we’re now at an elevated level. Now the growth rate may not continue at the same pace, but I do expect to see if that stay remain at this elevated level of demand, and that’s pulling through a lot of Hexcel composite material. To answer your question about sort of content, the more modern — the larger, more modern jets are pulling through significant shipsets. I think we called out that the large business jets are in the $200,000 to $500,000 range. And some of the larger ones, the largest sort of Gulfstream and the Dassault sort of Falcon 10X with the carbon wing are going to push beyond that.

So we’re extremely excited about further secular penetration of composites onto those platforms, which we expect to remain at elevated demand level for some time for the foreseeable future and beyond. So we’re very confident on the outlook for business jet.

Robert Spingarn: Thank you both, for the color.

Operator: Your next question comes from the line of Ken Herbert from RBC. Your line is open.

Ken Herbert: Yes, good morning, Patrick and Nick. Maybe, Patrick, really nice gross margins in the quarter. And you called out sales mix and absorption. As we look at where the incremental were this quarter, with the build rate plans, it doesn’t sound like maybe those tailwinds necessarily moderate too much, at least through this year. So how should we think about incrementals on the gross margin line? And is the current margin rate sustainable? Or how much are you expecting or thinking we should see that moderate over the year?

Patrick Winterlich: Yes. I mean, it was a great margin quarter, and the volume leverage was the key driver. I think as I said in my script, I would moderate expectations a little bit. We had a particularly sort of Hexcel fiber-rich product mix in Q1 which helped. It gave us a bit of punch. And going forward, inventory, I would not expect to continue to grow. If anything, we will now be stabilizing that and, if anything, bringing it down. So I wouldn’t expect an absorption tailwind either going forward. I mean, we do expect good quality margins but I would moderate down a little bit from what I would see is a little bit of an exceptional Q1 margin performance.

Ken Herbert: No, that’s helpful. And as I think about headcount and bringing staff back to support the higher rates, where are you in that process? And maybe at which level of staffing are you to support future rates? Or how much of that do you still have to go?

Patrick Winterlich: So as you know, we took our headcount down from about 7,000 heading into the pandemic to about 4,500. Today, we’re actually probably pushing 5,500. So we’ve almost brought back 1,000 people, which reflects the growth from the trough of the pandemic. I mean, our direct headcount will just pro rata. It will grow as demand grows. I mean, you can see sort of our guidance this year, $1.8 billion roughly just under the midpoint if you look at the midpoint. And if you compare that to the $2.4 billion, so that’s about a $3.75 billion level. So we will not jump again this year, a bit more in the coming years. We will manage indirect labor very prudently, but we will obviously not constrain ourselves to the growth opportunities, the R&T opportunities in front of us, and we will invest in people going forward. But the biggest mover on headcount is obviously direct labor, and that will follow revenue.

Ken Herbert: Great. Thank you very much.

Operator: And your next question comes from the line of Myles Walton from Wolfe Research. Your line is open.

Myles Walton: Thanks. With Flora now decided, and you alluded to it, but I was hoping you could talk to some of the relative content you’d have on the Valor. Is the shipset closer to a V-22 or CH-53K? And I guess how much of the content is still up for bid?

Nick Stanage: Well, Myles, I would say the content will certainly be above the Black Hawk. We’re still working on multiple packages both Valor. So it’s really premature for us to get a shipset at this point in time other than it’s going to be nice, it’s going to be a material driver for us and it will be more than the Black Hawk.

Myles Walton: Okay. All right. And then Patrick, you mentioned the restock benefit on the 350? Any way to size that? And the reason I ask is it’s hard to imagine that Commercial Aerospace sales don’t sequentially grow in some way, shape or form through the course of the year, which, I guess, is implied at the top end of your guidance still. So maybe if you can size that or give us any way to stay in the range.

Patrick Winterlich: Yes. I mean, we did — as Nick said, I mean, we entered the year around six and we’re now on a ramp towards nine in 2025. So we’re going to be in some sort of slope. It won’t be a perfect straight line. I think what we saw in the first quarter that perhaps was a little bit of a surprise with a lot of demand, and that must have included some restocking. And the A350 is a very Hexcel fiber-rich platform. And you have heard us say before, whenever we get that sort of pull-through of mix, it boosts our margins. So I do agree, we’re going to see steady growth. Whether we will get the same sort of restocking fiber-rich mix every time, I doubt, they definitely gave us a margin percentage boost in the first quarter this year.

Nick Stanage: I would just add to Patrick’s comments that in addition to the A350 in production, we’re also providing materials for the freighter. And Airbus has recently completed the central wing box that again has all Hexcel fibers on. And then lastly, remember, our supply chain for the A350 are over 40, 50 locations. So it’s quite a complex broad supply chain that does require some safety stock and some provisioning of materials, which we think some of that came through in Q1.

Myles Walton: Okay, all right. Thank you.

Operator: Your next question comes from the line of Kristine Liwag from Morgan Stanley. Your line is open.

Kristine Liwag: Great. Patrick, Nick, following up on the earlier questions on cash use, with the new Boeing airplane seemingly not in the horizon for this decade, the balance sheet where it is, the relatively minimal CapEx requirement, I mean, you’re going to be in a period of unprecedented growing free cash flow in this up cycle. So what’s your appetite to use the balance sheet or this cash for a transformative M&A? Do you think you need it? Are there anything of interest? Or potentially just returning 100% of that free cash flow to shareholders through dividends or buybacks?

Nick Stanage: Yes, Kristine. So thanks for the question. First, I would remind everyone that the lead time for material selection before a new airplane is lost, is in the vicinity of five years to 10 years. So you shouldn’t think that we’re not investing, working with our customers on the next-generation materials, processes and solutions for those types of platforms, which we are. Secondly, do we need to do M&A? We don’t view that we need to. That’s really how we drive our discipline and the value proposition to how it enhances our portfolio. So as you say, we have plenty of powder. We’re looking at various areas and targets and technology that we think would fit very well. That’s an active process that we have our team working on. But again, could we return more to shareholders, depending on the availability and the actionability of those targets? Again, it could fluctuate based on those factors.

Kristine Liwag: Great. And then in terms of the investment dollars, can you size that? Is this 5% of sales annually or less? How should we think about that level of investment that you’d have to do for the next airplane program?

Nick Stanage: Yes. We really don’t go there. We’re working with our customers on very a few technologies, whether you’re talking about fibers, whether you’re talking about matrix systems, whether you’re talking about in auto plate, out of auto plate, thermal set, thermoplastic, there’s a wide variety of technologies that will be used in different parts of the aircraft. I’d also say we’re firm believers that the penetration — the secular penetration of composites will continue to grow. So as we can make our materials more flexible, more adaptable to new processing, it opens up the window of the next composite airplane to be above 50%, who knows, maybe 70%.

Kristine Liwag: Well, 70% would be a lot. Great. Thank you very much.

Operator: Your next question comes from the line of Pete Skibitski from Alembic Global. Your line is open.

Pete Skibitski: Hey, good morning, Nick and Patrick and Kurt. Nice quarter, guys, On Industrial, the sales decline, I think the release mentioned wind. Was European wind down in the quarter? And what’s kind of the prospects of that going forward? Have you bottomed there or not? And last one is, could you just touch on are you seeing any headwinds in the balance of the Industrial portfolio or not?

Patrick Winterlich: Yes. So on wind, really, all our sales now are European-focused. As you’ll remember, we — investors pulled out essentially a plate making in the U.S. in 2020. We closed our wind in Colorado plant. We announced at the end of last year, the closure of our Taishan China plant. So those have now gone. So really, all our wind energy focus or at least the vast majority of it is in Europe out of our European production base. I think, as I said in my script, we’re now sort of stabilizing on wind. The last three quarters have been relatively level, but certainly a step down — fairly significant step down year-over-year if you look at Q1 ’22 to Q1 ’23. But we expect to continue to support the wind energy business at this rough level for some period of time, and we’re innovating some resin coating gel products, which we hope to see grow around the world actually.

In terms of the rest of automotive, nearly every segment was up. Automotive was up, recreation was up. And one or two of the key other industrial places were up. So we’re seeing general strength around the wind business. Wind has kind of merged back, if you like, to be one of three or four key elements of our industrial market.

Pete Skibitski: Thanks guys.

Operator: Our next question comes from the line of Sheila Kahyaoglu from Jefferies. Your line is open.

Sheila Kahyaoglu: Thank you. Good morning, Nick and Patrick. Thanks so much. You guys seem to be beating numbers without breaking a sweat here, Nick, I think you alluded to it, too. You’re watching labor inefficiency, supply chain. Others are stumbling on this. So I guess, what has improved over the last six months for you guys? And what are you guys watching most carefully going forward?

Nick Stanage: Well, I would be remiss if I said it was easy. I can tell you our teams have been working incredibly hard on managing the supply chain, putting out fires which were coming up quite frequently a few quarters back. And they’re not completely out but they have slowed down. So I’d say from our supply base, our supply consistency, lead times, we are definitely seeing an improvement, but it’s still not as steady and stable as it was pre pandemic. And we need to keep an eye on it because we have items pop up regularly. I’d also say on logistics and especially international freight on ships, the lead times have significantly improved and we’re seeing a downward trend there that — it’s too early to claim that it is back to 2019 levels. But again, we’re seeing positive movements in that area from our logistics and supply chain capabilities.

Sheila Kahyaoglu: Great. And I wanted to ask one on Defense and Space. I don’t know if you’ve ever given your breakout of how much space contributes. I wanted to know if your contracts are structured differently there, both within defense and space just given the customer bases.

Patrick Winterlich: So pure space sales are a smaller portion of our Space and Defense. I mean, Space and Defense dominated, it’s the vast majority of that segment that we call out. I mean, in terms of the contract, they’re probably slightly shorter in duration, but we have the same sort of commercial agreements and set up with those customers as we would with many other commercial customers — Commercial Aerospace customers, I should say. Probably, we don’t have decade-long contracts as we do see in the Commercial Aerospace world. But over time, that may develop as well. So similar structure contracts, probably slightly shorter term in nature, but nothing massively different.

Sheila Kahyaoglu: Okay. Thank you.

Operator: Your next question comes from the line of Richard Safran from Seaport Research Partners. Your line is open.

Richard Safran: Nick, Patrick, good morning. How are you? So I wanted to ask your V-280 question, a bit of a different perspective though. I think you made the point, correct me if I’m wrong, that you’re agnostic. However, one, Flora, now that the award has been made and the protest over, could you comment on the transition to the V-280 from the UH60, when the V-280 should start to impact your P&L? And how long you’re expecting UH-60 program to last?

Patrick Winterlich: Yes. So Rich, I mean, a good question. There’s going to be an overlap, I would expect. I mean, in terms of the V-280, we wouldn’t expect to see any real significant revenue probably for a couple of years into 2025. As Nick said, we’re still working on a number of packages to try and get more content on that aircraft, and it’s too soon to declare our shipset status. I would expect the Black Hawk program and the transition over to take several years. I think we’re going to see strength in replacement blade demand around the Black Hawk for some period to come. There could even be a little bit of a bump where we’re supplying to both programs for a period. But I think it will be a steady transition. I don’t think there will be a sudden drop in Black Hawk before the V-280 ramps, I think there’ll be an overlap and we’ll see a fairly gradual transition over time.

Richard Safran: I just wanted to ask a quick one on labor here. Nick, really kind of like — if you mentioned this in your remarks and I missed it, I apologize. But given the headcount increases, I wanted to know if you could offer a comment or two on how the training has been progressing, how quickly you’ve been seeing the workforce been ramping. And given the tight labor market, you even mentioned, if you’re getting the right people, I just have to think that based on your results, I mean, things seem to be doing a little bit better than you were expecting?

Nick Stanage: Well, I don’t know that I’d say they’re doing better than we expected. I think clearly they are improving rapidly. We did expect that. We continue to work our training programs. We continue to work our processes to try to eliminate as much of the potential human error out of our processes as we can. At the same time, during the pandemic, we took the opportunity to work productivity and efficiency improvements within our processes. So you’re seeing some of that flow through. But overall, I’d say the quality of the talent has been outstanding. And the ramp-up has been — I’d say, as we expected, which has translated into efficiencies that are climbing rapidly.

Richard Safran: Okay, thank you.

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

Michael Ciarmoli : Good morning, guys. Thanks for taking the questions here. Maybe Nick, last quarter, I think it came up at the longer-term kind of margin goals were becoming a bit more challenged. Clearly, you guys had some mix and you covered all the kind of tailwinds this quarter. But has anything changed? I mean, I think last quarter, we were focusing a lot on energy inflation, just general cost pressures. Maybe can you give us a sense, has anything sort of shifted or giving you more or less confidence in getting to those longer-term targets? Any color you might be able to add on pricing as well there?

Nick Stanage: Yes, Michael. So I’d say nothing has really shifted negatively. Actually, probably some positive shifts. Number one, energy, we’ve seen a decline in the energy especially in Europe as those markets stabilize and come down. I think the team has done a great job working with our customers to recover some of the inflationary items on labor and oil, and we’ve translated that well. And again, we’ve always driven for productivity improvements year-over-year, some efficiency improvements year-over-year, which is never ending in an operational environment. So I’d say I feel good about where we are. We have a way to go. We’re going to continue to leverage the volume growth. We’re going to continue to be tight on adding costs and certainly salaried resources, continuing to drive leverage and productivity going forward.

So as we grow, clearly, we’re going to be hiring both as Patrick mentioned, to support the operations and the direct heads virtually follow the revenue. On the salaried side, we’re going to continue to add the technologists, add the positions to help drive the growth for us to deliver well beyond the recovery.

Michael Ciarmoli : Got it, got it. That’s helpful. And then just one more, if I may, maybe going back to Rob’s questions on rate. On the MAX, I mean, if we’re going to keep production at 42 a month potentially by year-end, I think there’s been some commentary that maybe 300 leap composite shipsets were built last year. Is that creating a bit of a headwind for you guys? Just some of the composite-rich engine shipsets that need to be destocked? Or any other color there on MAX that you could talk about?

Nick Stanage: We don’t see the MAX of being a headwind for us at all. We see it as being an opportunity and a tailwind as the issues sit and as Boeing ramps up. Engines, I’m sure the entry manufacturers are working aggressively to maintain and to support the rates required by the OEs. And we’re certainly not prevented from — or have any obstacles in preventing us from supplying composite components for engines and the cells going forward. That’s not a headwind for us.

Michael Ciarmoli : Okay. Got you. Yes. I was meaning one of your suppliers had shipped to maybe 300 extra shipsets at the end of last year. And having to burn those down, they were kind of producing at flat levels for the leap this year. So that’s kind of what I was alluding to.

Nick Stanage: Yes. I think we’ve got that figured into our plan and it’s not a big obstacle for us.

Michael Ciarmoli: Got it, perfect. Thanks guys.

Operator: Your next question comes from the line of David Strauss from Barclays. Your line is open.

David Strauss: Thanks. Good morning, everyone. I know you guys — you maintained your — all your guidance for this year, including your revenue guidance. But within that, is there any change in terms of how you’re thinking about by end market, I think your implied growth in Commercial Aerospace based on your — the 58% you were guiding to of total sales implied only 13% commercial aero growth for the year. So does that still hold? Or is that are you now assuming it’s higher than that?

Patrick Winterlich: So I would say — I mean, we’re not ready at this point to adjust. We’ll watch the trend of sales through the mid-year points. And if we’re going to kind of call out revision to guidance, we would do it all at the same time. Now clearly, stating the obvious, and you’ve kind of just pointed to it, Q1 Commercial Aerospace was strong, a little bit stronger than we expected. But at this time of the year, as Nick talked about, there is still supply chain challenges for the OEMs. Now whether that’s engines or whether it’s other structural or electronic components, we don’t know what’s going to happen to the build rate. So yes, a good quarter for Commercial Aerospace to start the year, but a long way still to go and too early for us to sort of look at the color within our guidance, which we will obviously look at as we move through the year.

David Strauss: Okay. And on A350, you said you’re at six, headed towards nine over the next couple of years. But has there been any change recently in that demand signal from Airbus just in light of the fact, based on their deliveries, there’s some sort of — it looks like some sort of issue there where they only delivered five aircraft in the first quarter, so way below the production rate?

Nick Stanage: Yes. So we are obviously very close with Airbus and Boeing and our customers. And we see movements and the skyline that provides pretty significant detail, but we have not seen any changes that cause us to change our belief for forecast on the 350 ramp schedule.

David Strauss: Okay. One quick one to finish up. The inventory side, Patrick, can you just give a little bit more color exactly what’s going on there? I mean, your absolute inventory levels are pretty close to being back to where they were in 2019, yet your sales volumes are still 25 or so percent below. So why does inventory keep building from here? And how significant of a drawdown should we see?

Patrick Winterlich: So great question and great question for a CFO. So absolutely, I mean, as we talked to last year, we deliberately allowed our inventory to grow, recognizing some of the supply chain challenges and bringing in the materials. And we did that in order to make sure that we didn’t delay or impact our customers or at least we minimize that as much as we possibly could. Coming into this year, we saw the strong Q1 demand sort of late last year. So we built up some inventory levels, and that continued really into January and a bit into February to support the strong first quarter. What I would say going forward, and I think I said to an earlier question, we now expect inventory to stabilize and for inventory to come down.

And we think we’ve probably peaked at the moment. We’ll be focusing on the relative days of inventory that we hold. And I would expect — and we’ll be driving to release a bit of cash, I wouldn’t overstate it, from inventory in the coming quarters. But I certainly would not expect to see more inventory growth from this point onwards. So it was really all about supporting what was actually quite a strong fourth quarter for us and then seeing an even stronger first quarter as we came into 2023.

David Strauss: Great. Thanks very much.

Operator: Your next question comes from the line of Gautam Khanna from Cowen. Your line is open.

Gautam Khanna: Yes, thanks guys. Good morning. Patrick, you’ve probably answered this five different ways, but I just want to make sure I understood it. Sequentially, cost of sales flat with sales up $28 million or whatever it was. And that is just mix and productivity. Like you said, you built inventories so there was an absorption benefit. There was nothing else that was sort of one time that explains that?

Patrick Winterlich: No, it really was mix, which was good. All the Hexcel fiber that came through, the absorption into the finished goods always helps. And as I said, I think that trend — literally to the last question, that trend is going to now turn. So I wouldn’t expect to see favourable absorption. I mean, FX is strong if I look year-over-year, but you were talking sequentially. But that FX margin benefit of 80 basis points is one of the strongest sort of quarter-over-quarter benefits we’ve ever seen. But it was really about the Hexcel fiber-rich mix and about the level of absorption that came through along with good cost control and the rest of it. But those should be ongoing and improving the efficiency and productivity that Nick talked about.

Gautam Khanna: Terrific. And have you guys — could you tell us where you are on 87, rate, where you think you are?

Patrick Winterlich: Well, we’re moving up towards rate 5. We’re somewhere on that journey. We were kind of in the two, three last year. We’re now moving up towards rate 5. It’s hard to be specific. Again, to Nick’s point, we delivered to multiple endpoints, but we’re on that ramp rate up towards 5. I mean, we will obviously get there ahead of Boeing shipping at that level. So that’s the thing you should always bear in mind.

Gautam Khanna: Thank you, guys.

Operator: And your final question comes from the line of Ron Epstein from Bank of America. Your line is open.

Ron Epstein: It seems like most everything has been asked, but maybe just some big picture stuff. When we think about what potential new opportunities that are out there for you, I mean, like Boeing and Airbus are going to go on an airplane development vacation for a little while. What else is there out there? Is there some defense things you’re looking at? Or is there other things we should be looking for as potential additional growth drivers for the company?

Nick Stanage: Yes, Ron. So again, there’s always derivatives. More frequently the new aircraft, you see reengineering, and you should expect that, that will continue. And that requires a new cell. And just as a reminder, we have very strong position on engines and the cells and continue to drive the material for hotter temperatures, for better sound attenuation, for other applications that composites can’t fulfil today but can tomorrow. So we’re working on those. We’re working on secondary structures and certain elements that are easier to qualify and replace on derivatives. The A220 is a big opportunity for us. We’ve got various materials on the fiber, on the prepreg, on the technology side that could offer a great advantage and an opportunity going forward.

We continue to work with our customers on that. So in the Commercial Aerospace, and Patrick touched on all the penetration and the secular growth on business jets with Gulfstream, with Dassault and others big platforms, and again, just more and more of the aircraft transitioning over to composites. If I flip to Space & Defense, always a lot of technology opportunities there, which we set to new platforms on the Flora and space. It’s just a very diversified market, and we’re working on multiple programs along with sizable programs like the CH-53K, which is a very large program for us, and we’re ramping up as we speak in our Washington facility. So there’s a lot of opportunities out there. And again, we don’t neglect the wind and the industrial and the automotive all the other sub-segments in industrial that are keys are finding niches and areas where we can provide a sustainable competitive advantage.

So the growth opportunity, the areas where customers want stronger, tougher, more durable, lightweight materials it’s just continuing to expand. The question is on the economics and whether or not it fits within our target of what we want to invest in and where we want to drive the business going forward.

Ron Epstein: Got it. Super. Thank you.

Operator: And this concludes today’s conference call. We thank you for your participation. You may now disconnect.