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Hexcel Corp
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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 overhaul capacity aligned with demand and we are focused on reducing inventory and maintaining a lean and streamlined internal supply chain. We have cut overhead costs by reducing and eliminating discretionary spending, reducing benefits and more.
Like so many others, our team made sacrifices as we took action to stay in lockstep with our customers. Our team has accepted pay cuts, furloughs and shorter work weeks. The staffing was trimmed, others added to their workload. All this was done with the knowledge that this downturn is not the time to simply wait it out but rather an opportunity to keep moving forward to position our company to emerge even stronger when the pandemic subsides.
We're taking advantage of this time to refocus, restructure and draw on our resiliency to ensure that we continue to deliver strong shareholder value. Global demand for lightweight, stronger and more durable materials in all of our markets will grow and our technology and broad portfolio remains unrivaled in our industry. In addition, we have the most talented, diversified and experienced advanced composite material science workforce in the world. Those things have not and will not change.
Now I will share with you some of the numbers we reported last night. Sales in our third quarter were $287 million or about 50% down year-over-year. Adjusted diluted EPS was negative $0.29 compared to $0.90 in the third quarter of 2019. Despite negative adjusted operating income we generated $76 million of free cash flow during the quarter which brings our year-to-date free cash flow to $109 million.
As a result of this ongoing cash generation our debt levels are now lower than at the beginning of the year. Cash on hand is $68 million with an undrawn revolver balance of $698 million.
As part of our normal business cycle plus further tightening as a result of the pandemic capital expenditures this year are sharply lower than the past few years when we were investing in additional capacity for program ramp ups. As we grow and return to pre-COVID market levels over the next few years our installed capacity will provide the foundation for a long period of strong leverage and sustained cash generation.
Now turning to our three primary markets. Commercial aerospace sales continued to decline last quarter as global passenger air traffic remains at about half 2019 levels. Build rate reductions driven by the pandemic combined with significant inventory de-stocking led to the reduced sales levels. All major programs were down substantially with the largest sales impact related to the A350. Additional bill rate reductions publicly announced at the end of July by Airbus and Boeing are further extending the supply chain is stopping. However, we are encouraged as the 737 Max moves closer to recertification in the U.S., Europe and Canada.
As a reminder while the A350 is Hexcel's largest content program the narrow bodies such as the A320 Neo and 737 Max carry substantial Hexcel content in the engines and secondary instructions and they are typically produced at much higher build rates. Hexcel will benefit significantly when narrow body demand increases. For example, the Airbus backlog for their A320 Neo family is basically unchanged year-to-date despite the pandemic in nine months of production. At current production rates the A320 backlog represents 13 years of production illustrating that medium to long-term demand for these aircraft remains robust.
Regional business aircraft sales fell by about 50% during the third quarter compared to 2019. This is an area we are watching closely as increasing flight time for the smaller class business jet indicates an encouraging trend. In contrast with commercial aerospace, our space and defense sales remain steady year-over-year. We experience growth in U.S. defense programs, although this was more than offset by lower demand from a number of European space and defense platforms.
Overall, we remain confident the continued strength of space and defense as Hexcel is positioned on diverse programs including military aircraft, flight vehicles, launchers, helicopters both civil and military including growth programs such as the CH-53k and Airbus H-160, We see a lot of positive momentum and tremendous opportunities ahead. And I want to point out our ARC Technologies acquisition continues to perform exceptionally well. Space and defense now represents about 27% of our year-to-date sales compared to 19% for all of 2019.
Industrial sales continue to be challenged by the impact of the pandemic and changes in the wind energy business. Specifically the sales decline in our wind energy segment reflects competitive pressures that have led to a shift in demand from our advanced flask fiber prepreg to lower cost products.
As a result of this demand change in early November we will close our wind energy prepreg production facility in Windsor, Colorado. I want to be clear in stating that our relationship with our largest wind energy customer Vestas remains strong. While we anticipate the continued cost pressures for future wind turbine blades, we expect to maintain our market share and legacy blades and replacements for many years to come.
In addition, we are working today to innovate technologies and solutions to help our wind energy customers enhance the performance of their wind turbines further and continue to drive the economic case for wind energy as a source of renewable power.
In addition, we've been working successfully for several years to grow our automotive, marine, recreation and other industrial businesses and we continue to see good growth opportunities in several niche industrial markets. Our industrial team is excited by the opportunities and interests we've received on our materials, our engineer products and our solutions around the globe.
This was another challenging quarter for our business and we expect further disruptions before this pandemic ends. Still Hexcel remains a global technology leader with strong business execution and a great investment. Market challenges have forced us to make tough decisions and we have significantly reduced head count and continue to restructure the business.
In the end though, our team has done a phenomenal job. Although we are stretching our resources every day, we have never taken our focus away from innovating new technology and solutions to position us for new opportunities to grow the business, drive operational excellence and develop even stronger relationships with our customers.
Speaking of customers, let me take a moment to say that even though this has been one of the most difficult times we've faced, we can't ignore some of the more positive outcomes from this crisis. One of them comes from the need to think and act differently as we deepen our customer relationships during these months of social distancing and limited travel. For example, we are now spending quality time interacting with customers through virtual technology meetings. We're getting more of our talented team in touch with our customers than ever before. Without a doubt the way we do business is changing and we are embracing it.
Now I will turn the call over to Patrick to provide more details on the numbers.
Thank you, Nick. As a reminder the year-over-year comparisons are in constant 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 2019. This large percentage decrease illustrates the additional impact of the de-stocking. For reference two key platforms the Airbus A320 Neo and the A350 have production rate decreases of 33% and 50% respectively.
Additionally, the Boeing 737 Max sales were substantially lower year-over-year as production continued at a very low rate and there remains a high amount of inventory in the supply chain.
As Nick outlines, we expect commercial aerospace supply chain adjustments to continue into the first half of 2021. Space and defense represented 38% of third quarter sales and totaled $108.8 million; a decrease of 0.5% compared to the same period in 2019. U.S. space and defense sales increased year-over-year while the European space and defense sales decreased. We remain bullish for the outlook of our space and defense business globally.
Industrial comprised 17% of third quarter 2020 sales. Industrial sales totaled $49.3 million decreasing 38%. Wind energy weakness continued from the second quarter of 2020 as our major wind energy customers shifted their U.S. blade operation to an outsourced model rather than using Hexcel's glass fiber composite material to manufacture the blades in-house for the Americas region. As a result we are closing our Windsor, Colorado facility in the fourth quarter of 2020 which was dedicated to wind energy.
Our plan is to move some of the equipment to another Hexcel facility in the U.S. and then sell the winds at site. Our wind energy facilities in Austria and China continue to operate serving the European and Asian markets respectively. Automotive, recreation and other industrial markets remained weak during the third quarter reflecting the continued impact of the pandemic.
On a consolidated basis gross margin for the third quarter was 4.7% compared to 27.6% in the third quarter of 2019. As we discussed at our last earnings call we temporarily either select carbon fiber capacity during the third quarter and this has continued now into the fourth quarter to align supply with demand and avoid overproduction. Mix particularly lower sales of our carbon fibre also remain an earnings headwind.
We are continuing process improvements and cost realignment actions across the business and we remain agile and vigilant as we communicate frequently with our customers and assess near-term demand indicators in relation to realignment actions that we have taken.
Selling, general and administrative expenses decreased 28.3% in constant currency on $9.2 million year-over-year as a result of headcount reductions and tight controls on discretionary spending. Research and technology expenses decreased 25.8% in constant currency as we selectively reduced costs while continuing to balance our needs for innovation as a material science company operating an industry undergoing long-term secular growth.
The other expense category includes the restructuring cost to close our Windsor, Colorado facilities as well as severance costs primarily in Europe. We will be incurring additional severance costs in upcoming periods including further labor reduction actions already initiated in Europe. As Nick mentioned, we have unfortunately had to eliminate more than 2,000 positions, after roughly 7,000 positions we had at the beginning of the year. This reduction includes direct and indirect employees. Additional labor actions as well as furloughs and short-time workings have been initiated that will continue through year end and into 2021.
As you would expect we are aligning all direct raw material and direct labor costs in line with demand changes across our company. In addition, as called out in yesterday's earnings release we've put in place actions to realize more than $150 million of annualized overhead run rate savings including indirect labor, once we are through the normal lag for these cost reductions to take full effect.
Adjusted operating loss in the third quarter totaled $21.8 million as the low sales levels have led to significant under absorption of fixed overhead. The year-over-year impact of exchange rates was negative by approximately 40 base points.
Now turning to our two segments, the composite material segment represented 75% of total sales and generated a negative 9% adjusted operating margin compared to 21.2% margin in the prior year period. The engineered product segment which is comprised of our structures and engineered core businesses represented 25% of total sales and generated a negative 3.8% operating margin compared to 16.3% in the third quarter of 2019.
As we progress through the pandemic we are continuing to evaluate every aspect of our business including the structure of our various legal entities. Following an internal reorganization we recognize the discrete tax benefit of $43.9 million during the third quarter of 2020. We are not providing guidance on an effective tax rate going forward at this time due to the complexity of our tax situation as a result of the pandemic and the relative mixed shift in our global income pattern.
Net cash provided by operating activities was $83.4 million for the third quarter of 2020 and $157 million year-to-date. Working capital was a source of cash of $80.7 million in the quarter. We expect working capitals to be a source of cash during the fourth quarter of 2020.
Capital expenditures on an accrual basis was $6 million in the third quarter compared to $53.3 million for the prior year period in 2019. We continue to tightly manage capital expenditures. Free cash flow for the third quarter of 2020 was $76 million compared to $56.7 million for the comparable five year period, we remain focused on generating and preserving cash. We expect to generate additional free cash flow in the fourth quarter of 2020 as we continue to manage inventory levels and maintain strong receivable collections.
We increased our liquidity by $77 million as of September 30, 2020 compared to June 30, 2020 further strengthening our balance sheet. Our total liquidity at the end of the third quarter was $766 million consisting of $68 million of cash and an undrawn revolver balance of $698 million.
We have no near-term debt maturities. Our revolver matures in 2024 and our two senior notes mature in 2025 and 2027 respectively. When markets are predictable we operate with only a minimal cash balance as our business generates cash. Based on our confidence to continue to generate free cash flow in the fourth quarter of 2020 we've completed the repayments as the proactive $250 million revolver borrowing that was drawn in March in the early days of the pandemic.
Our leverage as of September 30 2020 is measured on a gross debt basis and was 3.25 times compared to 2.8 times at June 30, 2020. The change was due to lower 12 months trading earnings as net debt decreased $77 million at September 30, 2020 compared to June 30, 2020.
We remain within covenant conditions. We’ve recently worked with our bank's indication to accommodate the temporary impact of channels de-stocking by amending the revolver leveraged covenants for a period of four quarters and temporarily changing the covenant to a net debt basis for up to $200 million of cash.
This amendment illustrates our solid bank syndication relationship and preserves our access to liquidity by the revolver. Our share purchase program was suspended during the third quarter of 2020 and is now also restricted by the recent revolver amendment. Our board will continue to evaluate capital allocation priorities. Our focus remains on realigning the business and generating cash while remaining agile for future growth and channel destocking when production rates are increased.
With that let me turn the call back to Nick.
Thanks Patrick. The effort, the responsiveness and the way our team has adapted to this unprecedented time has been nothing short of outstanding. The commitment, the energy, 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.