Hexcel Corp (HXL) 2002 Q3 法說會逐字稿

Good morning. Welcome to Hexcel Corporation third quarter earnings release conference call. Today's call is being recorded. With us today is Mr. Stephen Forsyth, the Executive Vice President and Chief Financial Officer; and Mr. David Berges, Chairman, Chairman, President, and Chief Executive Officer. At this time, I would like to turn the call over to Mr. Forsyth. Please go ahead, sir.

Thank you, and good morning, everyone. Might I welcome to you Hexcel's third-quarter 2002 earnings conference call today, October the 22. With me is Dave Berges, Hexcel's Chairman, President, and CEO. As well as Michael Bacal, our Communications and Investor Relations Manager. Needless to say the purpose of the call is to review our third-quarter earnings release distributed last night. As always, we will be happy to respond to your questions after we have completed our prepared remarks.

Before beginning the formalities -- Before beginning, let me cover the formalities. First, I would like to remind everybody 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 different 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 actual future results for outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the Company's SEC filings, including our 2001 10-K as well as in the footnotes to today's press release.

Might I also remind that you 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 today constitutes your consent to that request.

While having taken care of the formalities, let me turn the call over to Dave.

Thanks, Stephen.

If you have had a chance to get through last night's earnings release, I hope you'll have concluded that Hexcel continues to perform well despite some terrible market conditions. For the third quarter in a row, commercial aerospace sales were up dramatically from last year, driving our total company sales down 16.5% to $201 million or about $40 million lower than the third-quarter of 2001. However, thanks to our efforts at cost control, adjusted EBITDA for the quarter was $26.6 million, within rounding of last year's $27 million. We had a net loss for the quarter of $3.6 million or 9 cents per diluted share, an improvement over last year's third-quarter results of a $12.8 million loss with 34 cents per diluted share. Despite the $40 million drop in the top line for the quarter our gross margin rate of 18.6% of sales improved over last year's third quarter of 18.2%.

Operating income and adjusted operating income were also up over last year. And we continue to feel good about our progress on cash management. We reduced net debt by $18.2 million dollars in the quarter to $636 million. Another four-year low. While the collection of $10 million of cash from our previously announced reduction in ownership interest in our Asian electronics joint venture certainly helped, a substantial portion of the decrease resulted from positive operating cash flows. In fact, on a year-to-date basis, cash from operations stands at $35.4 million, $11 million better than last year.

Now, let me cover the revenue picture by market. At $89 million, the 31.1% decline in Commercial Aerospace revenue for the quarter was just slightly more than the drop we saw in the first half. Remember that our sales tend to precede aircraft build rates by four six months, so we are now delivering against our customers 2003 deliveries. Recent customer pronouncements suggest that 2003 large air-frame deliveries will be between 575 to 585 aircraft, within the range we use to size our restructuring program and plants. Because we have a good balance between Boeing and Airbus, share shifts are less significant to us than others in the industry.

We are encouraged by a continued activity on the A-380 Airbus and the advanced development work at Boeing. Any new aircraft is likely to have significantly more composite materials, and while we are pleased with our ability to respond to the current downturn, we long to demonstrate the potential leverage any upside can bring.

Our industrial market segment declined slightly versus last year's third quarter to $61.5 million. And now represents more than 30% of our sales. While this segment and its many applications has been growing consistently, that growth was stalled this quarter due to reduced demand for bullet-proof vest materials for military contractors. A major marine vest upgrade program is coming to a close, and a similar refresh for the army has not yet been award. Civilian applications continue strong, but the military transition creates some uncertainty as to the overall soft body armor body sales trends for the next few quarters.

Sales for composite materials for wind turban blades returned to growth now that the U.S. tax credit has been renewed.

In the Space and Defense segment, revenues were up by about 3% over last year's third quarter or 6.5% year to date. As a new generation of military aircraft and helicopters continues to move into production, the revenue outlook remains one of growth.

We've mentioned before that some programs, such as the V-22 tilt rotor, satellites and launch vehicles are down, so our underlying growth in this market is being somewhat muted. As for electronics, sales of our glass fabrics for printed wiring boards were $14.2 million for the quarter, only 7% of our revenue. This is slightly down from last quarter, flat with last year's third-quarter revenues. We still have not seen evidence of recovery in this segment.

We've done what we need to do to make this business close to adjusted EBITDA neutral and look forward to the leverage a recovery could provide. As always, I offer no guidance as to when or even if this will happen.

From an operating standpoint, we performed pretty well during the quarter under difficult circumstances. The foundation of our performance progress this year has been our ability to attack fixed costs before revenues decline. Last November, we targeted a 20% cash fixed cost takeout, but we've already surpassed -- surpassed our head count goals for year end, and as a result, September year-to-date cash fixed costs are about 24% lower than 2001. We haven't stopped looking for productivity gains and don't intend to.

As for cash, we generated $18.2 million dollars in free cash flow this quarter. We had the help of the $10 million payment from reducing our stake in our Asian electronics joint venture but $8.2 million came from operations, earnings, working capital improvement and good capital expenditure control. Remember, we also have contractual opportunity to obtain another $23 million next year for the remainder of our interest in this Asian joint venture.

In January 2002, our senior credit facility was amended, relaxing the 2002 quarterly financial covenance to accommodate the Company's revised business plans and projections for the year. As of September 30, 2002, the Company was in compliance with all of its financial covenance.

As has been previously discussed, the Company will need to obtain a further amendment of the facility by the end of the first-quarter of 2003 to accommodate the continued weak Commercial Aerospace market in 2003. Our next significant debt amortization is the maturity of $46.9 million of 7% convertible subordinated notes due August 1, 2003. We are actively pursuing several alternatives to refinance this debt, and are considering ways to further deleverage the Company. We will issue an updated on this when appropriate.

Now, let me turn the call back over to Stephen to wrap up the financial details before we open it to questions.

Thank you, Dave.

Well, let me fill in those details and complete your review of the quarter. I will first touch on debt. Now for the first time, we have included this quarter in the news release a table that provides the detail of debt, the number of investors have asked that we do that ahead of providing it in the form 10-Q. And so you have that detail available to you now and we will continue that in the future. As Dave noted, debt reduced by $18.2 million to $63 -- $636 million as of September 30, 2002. The Company had undrawn revolver and overdraft availability under its senior credit facility of $83.5 million as of September 30, 2002. With the performance of the business, we were in compliance with our covenants.

Interest expense has sort of leveled off this quarter and last at about $15.5 million, a normalized level that will reduce as total leverage reduces. And our cash interest costs, this being one of the two quarters in the year when we pay bond coupons was $24.4 million.

Business consolidation and construction expenses for the quarter $4.7 million and capital expenditures, $3.3. We took the opportunity to update our guidance in terms of capital expenditures for the year, the year of 2002, and we now believe that they will be less than $16 million for the year as a whole.

On the tax front, the tax provision as you have seen in prior quarters was solely on European income. The Company continues to establish a noncash evaluation allowance against its generated U.S. net operating losses until such time as the U.S. operations have returned to consistent profitability.

Finally, equity in losses. As you are aware, during the quarter, we reduced our investment in our Asian electronics joint venture from 43.3% to 33.3% and received the $10 million in cash previously announced as a result of the restructuring of our minority interest with our joint venture partner. If one looks at equity losses for the quarter, they predominantly related to our two structures joint ventures in China and Malaysia that are ramping up production of aerospace composite components. And those losses this quarter are approximately $500,000. Just to remind you, our joint ventures do not affect Hexcel's cash flows. These are recognitions of noncash changes in equity in these joint ventures. For the prior period of last year, for the third quarter, our equity in losses from affiliated companies was $1 million.

Well, I think that covers the key highlights of our third-quarter results and it just turns -- time for me to return the call to the conference call operator and we will now be happy to respond to your questions.

The question-and-answer section will be conducted electronically. If you would like to ask a question, please do so by pressing the star key followed by the digit 1 on your touch-tone telephone. If using a speakerphone, make sure your mute function is turned off to allow your signal to reach our equipment. We will proceed in the order you signal us and we will take as many questions as time permits. Once again, please press star 1 on your touch-tone telephone to pose a question at this time.

We will allergy first to Steve Binder of Bear Sterns.

Good morning. A couple of things. Number one, you seem like you had pretty good reduction of receivables, inventories on the quarter. On the receivables side, can you maybe touch on the $12 million reduction. Which parts of your business does that come out of?

The receivable reduction in the quarter really just follows the fact that sales reduced for the quarter, particularly in Europe, the European vacation period. And so you are just seeing really the seasonal impact of lower revenues in Europe that tend to have a longer-term receivable -- European receivables in the 60-, 70-day mark. So, those drop out in the quarter and that would be in both our composites business and our now reinforcement fabrics business.

Can you kind of give us a sense of the next couple of quarters on how you expect working capital to trend here in the Q4 and first quarter of '03?

Certainly. You know, if you look at the sort of three key components of working capital, the receivables, inventory and payables. Your receivables and payables will track revenue. You know, to the extent that revenues go up, then would you see them rise a little, expended comes down, but we would expect to maintain comfortable ratios to that which we have really stuck to now for quite a few quarters. Inventory, our goal still remains to keep pushing on inventory wherever possible. While one can't always affect reductions each and every quarter, we still in this down demand environment want to be pushing for further reductions in inventory where we can get it. And so that remains an area of focus and attention for all of our businesses.

And can you maybe provide a little color -- I mean you touched on the electronics business a little bit, but what are you seeing from the supply standpoint in the end markets and pricing and where do you think we really are with respect -- have we hit an inflexion point yet or do you still see further weakness ahead?

In electronics, Steve?

That's exactly right.

I wouldn't -- I haven't seen anything that I would call an inflexion point. Just -- we are so close -- I mean, we are so low, Steve, that little bounces can look big percentage-wise. Just in general, I would say, we see nothing that excites us.

And with respect to aerospace, I mean, based on what you are hearing out of your customers, I mean, do you feel as though those build rates are -- that have been talked about for '04, you know, Boeing has officially said flat deliveries in '04 versus '03 and Airbus has hinted to the same. I mean, do you think at the end of the day that -- that at the end of the day, is that conservative enough or do you see some further downside.

I don't think I have a view that I would say is better informed than Boeing and Airbus. My guess is that the truth is that we are in a pretty volatile situation and until they sort out discussions with all of their majors, at least the U.S. majors, they won't be clear on 2004 and so I would say I wouldn't be either. What I am sure is we will do whatever it takes to follow their lead and we will have plenty of time, plenty of advance warning to get there.

Okay. And, Steve, the -- the decline of accrued liabilities in the quarter was that just restructuring cost or was there anything else in there?

There's no specific one item. So, you've got restructuring cost, some of the seasonal effects, things like vacation pays are being paid in Europe and things like that. But nothing out of the ordinary there.

And one last thing, you know, can you maybe just touch on the industrial side? You know, you talked about the softness of the military side there, but on the body armor side, but, can you maybe touch on, do you expect to resume growth in the fourth quarter or will sales start leveling off in that area?

I don't know exactly what will happen in the fourth quarter, Steve. In general ballistics has been really strong for us, and I think it's going -- it's going to vacillate a little bit for a couple of quarters. Outside of that, we generally still have the basics that we have talked about before, automotive, applications are growing, but we also need our particular vehicles to be built, and when it is back on a strong track again. So, it's the question of those three variables. The other pieces and parts of it are fairly stable.

Okay. Thanks very much.

Thanks.

to Adam Plissner of Credit Suisse First Boston.

Good morning.

Good morning.

While we are on the topic of the industrial segment, can you remind us, David, what really the breakout, I don't know how you termed it before, in terms of materiality, how big is the auto applications versus the wind market versus the general industrial applications or ballistics, you know, soft body armor? Can you give us an idea?

I'm pretty sure we have consistently not given you much of a breakout on that, but the ones that we talk about generally tend to be the biggest.

How about auto applications, you talked about some specific platform exposure, is there a specific OEM that you are more aligned to there as well?

No, not particularly. We have a couple of different products that are used by a number of the vehicles.

Okay.

A number of the manufacturers.

I mean, just -- in general, when you talk about those being the three biggest, when you talk specifically about auto and wind energy and ballistics, are they almost equal in size as well or not necessarily?

Adam, we don't break it out that way. I am sorry.

All right. Let's shift over to the commercial side. You have consistently stayed with your guidance of commercial aero being down 25%, 30% this year. We saw it down 30% in the third quarter, and you -- you know, you have also been consistent in saying that really the second-half revenues for the commercial side reflect 2003 first-half billed rates. How do we translate that and are you ready to give guidance for 2003 top line maybe specifically just for commercial in the context of what your expectations are for the build rate next year?

We haven't done that yet, Adam. We are in the midst of our budgeting cycle right now and assessing the latest input from the aerospace customers. We'll probably do that the next quarter.

Okay.

I think if you take a look at what the -- what the majors are saying for next year, you will see that they are not suggesting any radical change from their current run rates.

Right. Well, I mean, just the fact that you are already -- you know, like you said, running at run rates commensurate with the first half of next year's build rate you would think that it is less than the bill rate declines. But you are not ready to give that number out yet?

The bill rate declines -- remember, what you look at often is deliveries --

Correct.

-- for the total year.

Correct.

The bill rate declines are most dramatic at Boeing.

Correct.

-- who ran at a high rate -- what now looks to be a high rate -- from September all the way through -- almost through the first half and then they step down. So you are looking at average for the year. But the build rates that Boeing and Airbus are at are about what they have projected for next year for deliveries.

Okay. And maybe, Stephen, you talked obviously the seasonality in the third quarter, you know, related specifically in Europe with vacation time. How does Q4 in terms of seasonality compare to Q3 are holiday shut-downs equal to Q3 summer shutdowns?

The answer looking from a historic perspective has been we have seen marked seasonality in Q3 because we have 40, 45% of our revenue base in Europe, and a third of it goes away in the third quarter because people take a month's vacation and our customers shut their plants down and we shut our own plants down. Normally in the fourth quarter, you know you get some slowing around the holiday period both in the U.S. and Europe, but it hasn't been dramatic. That certainly has been the historic perspective. You are looking to this year and what may or may not happen, hoping with, you know, a down economy there's the potential that you could see more slowing at the end of the year, but it's, you know, too soon to judge on those things.

Okay.

Last year the third and fourth quarter were about the same but you had the September 11 -- just the start of the commercial aerospace slowdown in that.

Okay. Thanks, gentlemen.

Yep.

We'll go next to Sarah Thompson of Lehman Brothers.

Hi, just two quick questions. One, can you just tell us how much more you expect to pay out in cash restructuring payments this year?

Well require can't give you a definitive number, but, you know, there's an accrued balance of, what, $15 million about at the end of the third quarter. At this point, I would say some of that will flow into the next year. So you are going to see something in the order of what you have seen the last couple of quarters, maybe slightly higher in the fourth quarter, but you are not going to see the entirety of the balance in expense this quarter.

Okay. And then can you just give us some insight into why you are able to reduce your Cap Ex budget. Do you just have some room in there? Or are you just delaying projects? A little bit more information on that would be great.

We have tightened up the scrutiny on Cap Ex projects and made sure we are utilizing the best -- you know, the capacity that we have available in our many plants instead of leaving -- leaving work dedicated to a specific plant. We have also made some pretty good gains with some six sigma projects on improving our yields, reducing what was expected with respect to capital requirements. So it's -- it's just a matter of tighter scrutiny and sensitivity to managing cash. We are still investing in those areas where we see growth and where we have cost reduction opportunities.

Is $16 million a number you could keep constant in 2003 as well?

We are not projecting 2003 yet, because we haven't finished the budgeting cycle. I would say, though, we had a real slow start this year because we wanted to make sure that we modified our burn rate in all of our plants. So I would think we would be back at a little more normal course like what we projected for this year.

Great. Thank you.

Sure.

We'll go next to Hillel Oshen of Duetsche Banc.

Actually all my questions have been answered. Thank you.

Once again, if you would like to pose a question press the star key followed by the digit 1. We will go next to Peter Sarkin of Conseco.

Hi, thank you. Can you discuss the current level of shipments between Boeing and Airbus if you have seen any mix? You have talked about how the deliveries next year are within your range, but are you seeing strength in one -- or weakness versus the other?

I am not sure if I understand the question. We're delivering to their build rates, so our shipments have to deal with the mix of aircraft that are being built.

Right. I was just wondering if you were seeing further declines in one versus the other, for example, for the decline in Boeing, perhaps, and maybe increases in Airbus.

Well, if you are trying to ask if we know something about their build rate that you don't know, I am not sure what you know. We have -- we have schedules that we see well in advance, all suppliers do on that confidential basis to make sure we are aligned and we are capable of supporting their needs and requirements and that's what we ship to.

Okay. In fourth quarter, what are your expectations to end the year on a net debt level?

I don't think we are projecting anything, but I think we are making -- we are demonstrating pretty good cash management performance. We have some restructuring cash outflows to go, but nothing like what we had last year. It's an easier interest quarter than most other quarters. Tax can tend to be a little higher. Stephen already talked about working capital. I would say -- you know, earnings, you will have to pick your own number, but I think we should hold our own on cash for the quarter or thereabouts.

Okay. And finally, you said you will make an announcement when you have got the actual situation resolved with your subordinated notes that are due next year. Would it be fair to say that it is probably going to be resolved next year or is this something you're working continue to complete in the fourth quarter?

We almost got all the way through the call without that question. [ LAUGHTER ] We're -- when we are ready to announce something, we will announce it. That's about all I can give you right now, Peter, I'm sorry.

Thank you for your time

We'll go next to Luke Williams of Micro Capital.

Good morning.

Good morning.

For those of us that are not intimate aerospace analysts, could you kindly review the carbon fiber content that will be part of some of the newer aircraft and when they will start to figure in to be an important part of your mix?

Well, Luke, the biggest one that we are all focused on is the Airbus A-380. We've said before that it could have ten times the composite materials that the 747 has, because of the generational change. I think the projections for -- from Airbus are that it will be in the neighborhood of 18% of the weight of the aircraft. And, you know, we are all working on trying to, you know, help qualify parts and processes and materials for that aircraft right now. So we are starting to see sales to the A-380 program this year and we will see more next year and it steps up significantly beyond that. It goes into service on the current schedule in 2006. But, of course, there are a lot of development aircraft that are built before 2006. So it will start to give us some good momentum soon.

Could that be 10% of your sales in 2005?

I haven't done that math. And I don't know exactly what our share will be at this point.

Okay. Are there any other big aircraft? Any of Boeing's? That are real step-ups?

Well, the military aircraft, many of them are in a ramp-up mode. And we are involved in tens of military programs in the U.S. and in Europe. They tend to be growing as, you know, the euro fighter ramps up and F-22, F-18, the V-22 if it goes, JSF and so forth, they are all generally helpful. Europe, they're still talking about A-400-M transport, which would be a very big boost to the composites industry as it is projected to have a composites wing. That has not yet been officially launched yet, but that would be good news for us.

Okay. What is it -- what's the fiber content of that aircraft?

I don't have a percentage, but it will be -- it will be a very high percentage. Actually military in general are very high percentage, but they are just smaller aircraft. The A-400-M, is transport so it will be a bigger aircraft. Thank you.

We'll go next to Ashish Pant of Fairlawn Capital.

Hi. Could you just review the pricing trends that you have seen? In particular, you know, I don't know what states you are at in terms of negotiating with your customers, but any sense of pricing, number one? And number two, if you can talk a little bit about if you see any sort of, you know -- what are you seeing in terms of competitive activity particularly from international competitors?

Well, we've got quite a few markets so it is a little tough to cover. Let me just throw out a couple of general comments. In commercial aerospace, in military, we tend to operate under very long-term contracts. Multiyear contracts. We tend to reach agreements on specific programs or specific materials with -- with major primes. Those are negotiated every couple of years. Occasionally there is a new program that comes along where we -- where we revise a contract such as the A-380. So there's quite a bit of stability in our projections with respect to pricing in our aerospace markets, which is most of our markets.

If you go to the other extreme, electronics tends to be more price sensitive and driven to a great extent by the raw material, that is glass yarn. So that market behaves a little bit more like a chemical business that fluctuates based on supply and demand. So as you might imagine, we are seeing some significant price pressures in that market, but also our glass yarn costs are declining at the same time. So it depends a little bit on the market, but that's sort of a general view.

Just another comment on the competitive landscape. Could you give me a comment there? And just related with the pricing issue, is it -- is it true that, you know, your negotiation ability with your customers is a function of also the price of substitutes, particularly aluminum prices? And how are pricing trends in that market sort of impacting you guys?

As for competitive landscape, particularly internationally, I would say I don't see any dramatic material shifts in behaviors with the possible exception of -- as we mentioned in the release, printed circuit boards to our -- are being manufactured in China to a greater extent today than two years ago. And to the extent China buildout capacity and our customers source their boards from China, it is likely we will end up with more of an Asian competitive thread to our electronics business. At this point, it tends to be in heavy yarn, lower cost, lower margin product family, but that's -- that's a little bit of a trend shift that we noted in the release.

The second question was ...

It was really substitutes, pricing of substitutes.

Substitutes, sure. I think -- I think a designer is trying to balance the weight and performance and stiffness and flexibility. Everybody knows aluminum is much cheaper than carbon fiber reinforced plastic, but designers are -- are after weight to such a degree that I think it's not a real competitor. I think it has been over the years as we tried to take advantage of the volumes that have come into this industry to be able to project or allow the designers to project that with volumes, we will be able to get scale and carbon fibers can be less expensive than they currently are. I don't think they will ever compete on a cost basis with aluminum, and it hasn't slowed the penetration of composites in the aerospace industry.

From our discussions with, sort of, people in the industry, it seems to us that, you know, there is some kind of a price ratio that the purchasing people at Boeing and Airbus sort of keep track of, of course, to the benefits of carbon fiber, reinforced plastics. Is that sort of true? Does that become a starting point for price negotiation at all or is that not true?

Well, I think by the time it gets to purchasing, the design decision has been made. I would say that trade studies are made, though, in the designer's arena to try to calculate whether the advantages of carbon fiber are worth the premium that is likely to result. So I think almost every composites application have thresholds. You go to one extreme and it's the cost of a launch vehicle to put a satellite into space. There is a huge cost premium to any kind of weight. So carbon fiber tends to be the material of choice in structural applications and space applications. To a lesser extent, aircraft. But I am sure those are the key driving factors at the design phase.

Thank you very much.

Okay.

We'll go next to Andrew Landoff from APS Financial Corporation.

Hi. You talked about potentially getting some additional cash from the sale of your Asian joint venture next year. Can you give us any idea as to the timing of when that cash flow might be coming to the Company?

We haven't made a decision with respect to that at this point, but we have a put option to sell our shares any time after July 1, and our partner has a "call" option to purchase our shares. I believe, also, at any time after July 1 of next year.

For a six-month period.

For a six-month period.

Thank you.

Once again, if you would like to ask a question, please press the Star key followed by the digit 1. We will go next to Adam Plissner of CSFB.

Just one follow up on some of the share commentary you made earlier, David. When you were in discussions with Airbus, I guess in particular with the A-380 program. Is there any, I guess, reluctance on their part -- you historically have had such a significant share with Airbus in particular, I know you are encouraged by the growing content of composite material on the A-380, but where are you setting your targets and sights on a go-forward bases in new platform introductions especially with Airbus in terms of what kind of share can you retain and has your financial stress position at all making it more difficult in terms of negotiations?

Well, our target is 100%.

Right.

That's easy. And I can't speak for their view on our financials. I know we have been a very good supplier to them for many years. We have facilities in most of the areas where they build the aircraft. We have stronger relationships, a great database with our technologies, and I would hope that at the end of the day, we'll -- we'll get our unfair share.

Okay. Great. Thank you

We'll go next to Daniel Alba of TCW.

Hi, my question is related to the call option. How much can the Company call? At what -- what's the amount for that?

The remainder of the shares is $23 million both ways. We can sell for $23 million after July 1, and they can buy for $23 million.

So it's the same?

Pardon me?

It's the same amount then?

Same amount, yes. Same amount, yes.

Great. Thanks a lot.

Gentlemen, at this time, there are no further questions in the queue.

Okay, thank you very much, everyone. We will talk to you again as soon as we have some news to report or otherwise, at the end of the next quarter. Thank you.

That concludes today's conference call. We thank you for your participation. You may disconnect at this time.