Hexcel Corp (HXL) 2003 Q4 法說會逐字稿

Good day everyone and welcome to the Hexcel Corporation fourth quarter and 2003 earnings release conference call. This call is being recorded. With us today are Mr. Stephen Forsyth, the Executive Vice President and Chief Financial Officer, and Mr. David Berges, Chairman, President, and Chief Executive Officer. At this time I would like to turn the call over to Mr. Forsyth. Please go ahead, sir.

Good morning, everyone. Might I welcome to you Hexcel Corporation's fourth quarter, 2003 earnings conference call on today, January the 27th. With me today are Dave Berges, Hexcel's chairman, president and CEO as well as Michael Bacal, our investor relations and communications manager. The purpose of the call is to review our fourth quarter earnings release distributed last night. As always, we will be happy to take your questions at the end of our prepared remarks.

Before beginning let me cover the formalities. First I would like to remind everybody about the safe harbor provisions relating 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 may 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, including our 2002 Form10K and its amendments as well as today's press release. Lastly, might I also remind you that this call is being recorded by Hexcel Corporation and is a copyrighted material. It cannot be recorded or rebroadcast without our expressed permission. Your participation on this call 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 read last night's earning release, I think you will agree Hexcel had another solid quarter in what remains a challenging marketplace. As we have seen throughout the year, the strength of the Euro and the British pound inflated revenues versus last year and makes performance comparisons more complicated. In this quarter's release we provided our estimates of revenues for the quarter and year-end at the same rates as last year. What we call constant currencies to help you understand real volume trends. All other financial references remain in current dollars. As an example, our fourth quarter sales of $221.4 million was up 14.9 million from last year. But 9.3 million of that was just due to the currency shifts.

On a constant 2002 currency basis, sales would have been 212.1 million, 5.6 million higher than last year or 2.7% real volume growth. Operating income was $10.7 million for the quarter. As you compare to last year's 12.3 million, keep in mind that business consolidation expenses were 1.8 million higher at $1.6 million versus a reversal of 0.2 million last year and the depreciation expense for the quarter was $2.4 million higher at 14.5 versus 12.1 last year due to the exchange rates and the accelerated depreciation associated with our business consolidation programs. Also recall that the fourth quarter last year included 1.5 million of expenses associated with our then planned-issuance of convertible preferred stock. Taking these factors into consideration, operating profitability was up almost 8% over last year for the quarter.

Gross margins were up 1.7 million, though slightly down in percentage terms compared to last year, given the relative strength of our industrial sales. Below gross margin, we, like many companies, have been faced with increased pension expense, higher insurance premiums, new regulatory compliance costs, currency fluctuations, all difficult to control. But our aggressive productivity initiatives have more than offset these effects. A good indicator of our cost control is our head count, which, despite sales growth, was down for the 10th quarter in a row. Excluding business consolidation and restructuring expenses, the company's pre-tax loss for the quarter of 2003 improved -- for the fourth quarter of 2003 -- improved $2.1 million over last years loss of 2.3 million.

Taxes of 7.6 million were up 0.4 million, if you exclude a $4.7 million deferred tax asset write-off which Stephen will discuss in a minute. As for cash we have reduced net debt by $16.7 million in the quarter, entirely from operations.

For the full year, net sales were $896.9 million, but only $857.3 million in constant 2002 currency. Almost flat with 2002's 850.8 million. Gross margin increased to $174.5 million, from 161.3 million last year, up 50 basis points to 19.5% of sales. Operating income of 57.8 million was off slightly from last year's 60.2 million but was influenced by the same factors as in the quarter, with depreciation finishing $5 million higher at 52.2 million, and $4 million of business consolidation expenses, 3.5 million higher than '02, a solid performance from operations with little help from real sales growth.

As for net income, if you exclude this quarter's non-recurring write-off of the Belgium tax asset, we cut our losses to 6.4 million, less than half of last year's loss of $13.6 million.

For me the high point of the year was our debt reduction and capitalization -- recapitalization. Total debt net of cash end of the year at $441.7 million, down 172 million compared to a year ago, 112 million of the reduction came from our refinancing, 29 from asset sales and $31 million from operations. While we continue to focus on cash, our leverage is now appropriate for our view of the market. And we have the liquidity to fund our expected growth. Perhaps of greatest importance, our scheduled debt repayments are only about $2 million a year until 2008.

Now I would like to cover our sales by market to give a better sense for our 2004 sales projection of 900 million to $1 billion. If you adjust the constant 2002 currency, our revenues by market for the quarter followed the trends we have seen much of the year, constant dollar commercial aerospace revenues were down 7.7 million in the quarter due to year end inventory balancing by customers.

So far the year, this segment was down a 11.9 million or 3%. But as you can see in table A, the relevant sales for our structures business declined by over 20 million, reflecting both Boeing build rates and the continued transition of work to our Asian joint ventures. So outside of structures, our commercial aerospace sales have stabilized and are already benefiting from the A380 program at Airbus. As for 2004, Boeing and Airbus have indicated deliveries that will be comparable to their combined 586 planes in 2003. So we expect another year of stable revenues in this market.

Industrial market sales showed strength in the quarter, up almost 14% in constant currency terms driven by another strong quarter of elastic fabric sales and increases in our recreational applications. With the current strength of military demand we expect ballistic sales to remain strong through 2004 and wind energy revenues to grow due to market growth and product evolution. So in total we expect moderate growth in our industrial segment in 2004.

Sales to space and defense were again strong, consistent with the 17% constant currency growth we have had for the full year. The gains were broad based and included some non-recurring tooling. But the growth in sales to U.S. and European rotor cap programs were particularly strong. Because our space and defense sales were up so dramatically in 2003 we expect revenues from this segment to grow more modestly in 2004.

In constant currency, electronics revenues for 2003 were 50.6 million, compared to 58.3 million last year. While total sales were down year-over-year, we did see some late year improvement in the U.S. But it was more than offset by decline in European sales. Our electronic sales out look remains clouded. Meaningful improvement in our printed wiring board substrate revenues will depend upon growth and demand from sectors such as telecommunications and major IT infrastructure which have yet to show signs of a material recovery.

Looking back, I think we responded well to some tough challenges. In 2002, and in 2003, we did what we had to do to redefine both operations and our capital structure. As we go forward, we will increasingly focus on growth and returning to consistent net income profitability. To build for growth, we are making strategic investments in R&D, sales, marketing as well as manufacturing.

In addition, with significant shifts to carbon fiber composite designs in aerospace, wind energy and recreation, we see the opportunity to move advanced composite materials from niche to mainstream, by undertaking what we call industrialization moves.

We continue to work at a number of rationalization efforts in Europe and last night we announced our intent to consolidate the activities of our Livermore, California, facility into other operations, principally our Salt Lake City, Utah plant. These are difficult multiyear projects. While these actions will produce long-term savings, the main objective is to position us for high volume process automation, and the industrialization of our products that will bring economies of scale to advanced composite materials.

As for our focus on net income, driving growth and productivity will obviously improve operating income. But we expect progress in other areas as well. The reductions in total debt have and will continue to reduce interest expenses going forward.

Our Chinese and Malaysian joint ventures are making steady progress towards profitability as their production volumes grow. So we expect improved equity and earnings from affiliated companies. In addition, we are taking actions to better balance our financial leverage geographically and thus the tax obligations of our foreign operations. All of this should drive us towards consistent generation of net income. Now let me turn the call over to Stephen before we open it up for questions.

Thank you, Dave. Well, let me fill in a few brief details you may need to complete your review of the quarter. You will note that we have provided a number of areas of guidance in this quarter's release.

Firstly, we provided our estimates of total revenues and market segment revenues and constant currency. Thank is at the same FX rates applied in the applicable periods in 2002. You may well ask, do the increases in the Euro and the British pound also inflate our gross margins and operating income? And the answer is that the impact there is more complicated. As many of you are aware, most of the aerospace industry does it's business in U.S. dollars. Hexcel is no different and as a result, Hexcel has a significant amount, which European manufactured aerospace sales denominated in dollars, that is, we sell to our customers in dollars. However, we manufacture those products in Euro denominated costs. So as the Euro strengthens, absent hedging, the sales price in dollars would remain the same but the product cost measured in U.S. dollars increases, and that squeezes margins.

Now, we can use hedging to offset some of that impact and we do do so. On the other hand, we also have sales where we sell in Euros and manufacture in Euros. And there, if the Euro strengthens, costs, sales and profitability all increase measured in U.S. dollars but percentage margins remain the same. So the net effect is as the Euro strengthens we have some product lines that become more profitable in U.S. dollar terms and some that become less profitable. Hedging helps to harmonize some of those effects. But the net result is that the strengthening of the Euro and the pound is less pronounced in terms of our margins and operating profitability than it is on our sales and hence our focus in explaining the sales changes.

Might I pick up where David left off and talk a bit about our business consolidation programs. During 2004, we expect the cash costs of our business consolidation programs to be on the order of $7 million. This includes the costs associated with the new Livermore, California initiative, described in our release, as well as our existing programs, which are predominantly in Europe. We estimate business consolidation expense, what goes through the P&L, will be approximately $4 million in 2004. So the balance sheet accrual will reduce by $3 million over the year. We anticipate that the average exchange rates where they were in 2003 depreciation expense in 2004 will be approximately 52 million, comparable to this year. That includes the normal depreciation of our PP&E but also the impact of accelerated depreciation under some of these aforementioned business consolidation programs.

Lastly, we anticipate capital expenditures in 2004 to be on the order of $30 million. As Dave noted, with the light that our total net debt of cash has decreased in the quarter and the year, in the quarter by 16.7 million to a figure of 441.7 million as of December 31. Now, that's down a 171.8 million from where we started the year, as Dave has described, driven by our refinancing, our asset sales and our operational performance. Interest expense was 12.5 million for the quarter compared to 14.4 million a year ago, reflecting the benefit of some of those reduced net balances. For the year, our interest expense is at 53.6 million, down from 62.8 million last year. As in prior quarters, we provided you a table, it's table C at the back of the release. The details for cash components, what are true coupon, what are expenses and then the long cash amortization of financing cost, so you can amortize our expenses more in detail. And table E clearly provides the capital structure and you can see the components of coupon by items of our debt

Let me next touch on taxes. The company's tax provision for the quarter was 7.6 million and predominately for taxes on European income. The company paid 1.1 million in net cash taxes for the quarter. During the quarter the company included in its tax provision, the non-cash write off of a deferred tax asset in Belgium of $4.7 million. This action was taken because, due to the weakening dollar among other matters, the company determined that it was not likely that these deferred tax assets would be realized in a reasonable period of time. If you look at our total tax position, the company will continue to adjust its tax provision rate each quarter, through the establishment of release of a non-cash valuation allowance, which now is attributable to currently generated U.S. and Belgian net operating losses. Until such time as our U.S. and Belgian operations respectively generate sufficient taxable income to utilize the net operating losses in full. The tax footnote in the Form-10K will provide you with the details of the provision between the U.S. and Europe as well as to where we stand on our net operated losses carried forward.

Lastly, if I could turn to equity and losses. During the quarter, equity and losses are affiliated companies was just $300,000. Primarily reflecting the losses being recorded by our joint ventures in China and Malaysia as they ramp up their production of aerospace deposit structures. As is evident if you compare the 2003 performance to 2002, losses in the fourth quarter of 2002 were 1.5 million and the quarterly trends over the last year are J.B.'s are reducing their losses as they continue to increase their production volumes. And just to remind you, our J.B. results do not affect Hexcel's cash flows. This completes management's comments on the fourth quarter and full year results for 2003. If I may return the call to the conference call operator, we will now be happy to respond to your questions.

[OPERATOR INSTRUCTIONS]. We will take our first question from Hilal Oshen of Deutsche Bank.

Good morning, gentlemen. Nice job. David, can you give us little more color, in your comments, you know, discussed how you're looking to, you know, move composite materials more to the mainstream, you call industrialization initiatives, can you give us some more color what you guys will be doing this year or doing differently?

Well, it's mostly to differentiate between the kinds of projects that we under took two years ago. Two years ago we took out 30% of our workforce over an 18-month period, it seems to me. And so there was real quick moves and a real quick pay back. Though it was painful, it was quick. The projects that we're working on now are much more line rationalizations, moving facilities, consolidating facilities, and processes so that we can get the benefits of automation and industrialization. So in the example of the liver more, California facility, it has many of the same kinds of products processed through it that our joint venture in Japan does and the European operations do and the Salt Lake City plant does. The volumes are down, as aerospace cycle is down, and it's the right time to put them together so that when they come back, we can invest much more efficiently and effectively.

OK, thanks. And just a question in terms of '04, operating cash flow or free cash flow. Would it be your expectation that we're going to see a step up a little bit in CAPEX with some of the growth initiatives you guys see, some increased spending on business and consolidation costs offset by lower cash interest payments? Would it be your expectation that the company will generate, you know, at or north of where you guys generate free cash flow this year? I think this year it was in the high 20s of free cash flow?

Well, let me try and answer that, Hilal. Clearly generating cash remains the focus of the company. I can't give you a precise forecast, as we have not provided explicit guidance on that. But you have seen our track record of managing our working capital to get the best utilization, continuing to push on operating profitability performance and clearly we're going to try to deliver another good cash performance for the coming year.

Thank you very much.

We will go next to Brad Bryan of Jeffries & Company.

Good morning, gentlemen. I had a couple of questions. One of you could just give a little additional detail about the fourth quarter aerospace sales, so as you mentioned the customer inventory rebalancing. If you could perhaps explain that in a little more detail, given that they have been running a fairly steady production. I guess I was little surprised by that. Second, if you could comment on your out look for cash taxes in '04.

On the sales, fourth quarter often has some funny puts and takes. Remember, we're delivering four to six months ahead of the actual bill schedule for the OE. So, our customers often are subcontractors or structures makers, we maybe have 20 or 30 customers between us and Boeing and Airbus. Whether people have Christmas shutdowns or extended shutdowns for inventory balancing or targets for the end of the year, we oftentimes have push ousts at the end of the year if we're not in a ramp up mode on a land rate schedule. I can't think of anything unique that happened in the quarter that would indicate that something has changed in the marketplace. I just think you have to smooth it and average it over the periods.

The second question -- I forget what it was, but Stephen -

The cash taxes for the coming year. You saw cash taxes in 2003 at about $9 million, $8 million for 2002. Clearly, you know, what we're trying to do is we sort of manage our operations is to constrain the growth in that payment as our operating profitability improves. And to do so as we described by making sure that our European operations have an appropriate level of leverage. I can't give you a hard number but the goal is to continue to try to constrain that growth and get a better balance on our total tax expense.

Very good. If I may, may I ask one follow-up question? And that is, given that you should have some pretty decent cash flow generation in 2004 and if you have minimal bank debt, what are your plans for utilizing that free cash flow in '04?

You know, we don't sort of pre-announce what debt we might repay but clearly to the extent that we do have free cash available, you have seen we would apply it to the reduction of debt and we would continue to do that.

Very good. Thanks.

[OPERATOR INSTRUCTIONS] We'll go next to Jason Logue (ph) of Lord Abbott (ph).

Yes hi Gentlemen, just a few questions. Looking at your sales guidance for '04, it's a wide range of let's call it flat up 10%. Can you just give us a little color on where you see on the high end of that range, where that growth would be coming from?

Do you want to tell me what the exchange rate is going to do next year?

So, it's basically exchange rate-related?

No, not entirely. But we -- it's a wider range maybe than we otherwise would give to put a little breathing room there. If you were to take today's -- or these fourth quarter sales and just normalize those for the exchange rate at the end of the year, you would get part of that growth. So, you know, by segment, we kind of point out that we think commercial aerospace will likely be pretty flat. Industrial, we expect to see some growth, space and defense, expect to see some growth. And electronics is pretty small and we don't have much of a view on that yet. Principally in space and defense, it's industrial. But I don't -- I wouldn't -- you know, remember it, when commercial aerospace build starts up we will start six months prior so we don't really have visibility until 2006 build rates yet, and so, you know, if things improve in aerospace, we could even see some help at the end of the year there.

OK, just going to the electronics business, obviously you have seen some quite good news around the tech sector. And given the fact that you came in more flattish than anything, can you just give a little color on, you know, if there's some lagging situations there?

Well, we've talked about this a couple of times. What's important to remember with our products is that we tend to focus on and expect our growth to come from the real high end types of products. The lower end products, the kind of personal digital devices and things you might carry in your briefcase tend to come out of China and we don't participate in that market locally, other than, you know, product that might be shipped over there. So, when you think about ourselves you have to be looking at the high end and telecom and space stations. And while there starts to be some signs of improvement there, a lot of the explosion you're seeing are, you know, toys for your living room, it's not the kind of things that drive our growth.

OK. I appreciate it.

[OPERATOR INSTRUCTIONS]. We will go to Adam Zirkon of RBC Capital Markets.

Good morning, guys. Congratulations on the quarter. Few quick questions for you. Number one, on the military front, you mentioned a second ago that you expect the military business to be up next year. Though several people have said that the size of the ongoing military operations, particularly those in the Middle East, are going to be scaled back over the next 12 months. So, I'm wondering what is driving that growth going forward?

Well, remember most of our end products are our equipment, our big airplanes, helicopters, rockets. They're not things that are seeing significant shifts because of the action in the Middle East. It has more to do with sort of across-the-board rearming and rebuilding from the quiet period post the cold war. So almost all of the newer aircraft programs are either running at full production rates or moving towards higher rates. Just a couple of programs have had step downs in recent years of note the European fighter aircraft I think has slowed a little bit, the F-18ENF has slowed a little bit. Almost everything else is either running at full rate or on its ramp upwards. That's what is driving our growth more than the action in Iraq.

On the commercial aircraft front, much hoopla has been made about some of the upcoming Boeing and airbus programs, particularly the 380 and the 77. I know Boeing in particular has stressed the use of increasing lots of composite materials in the (inaudible) project. Is there any upside for you guys there or are you not much involved in it?

I would say any new airplane is upside by definition. Because I can't think of a single airplane in commercial or military that has come out that has not had more composites than the aircraft that it replaces.

I suppose I would have no luck if I asked you to quantify that, right?

Well, Boeing has indicated that the composites as a percent of the airplane by weight will be in the 50% range. The A380 is north of 20% now, while the A400M is a military transport, it's a large transport, so I kind of throw it in with the pile. And airbus is talking about carbon fiber composite wings. So, that will be north of 30%, so what we see happening is a pretty dramatic shift going forward towards composite. It's been gradual over the years. Military was gradual for a number of years and then it suddenly moved up to fuselage and wing. We see commercial aerospace moving in that direction. So in the airplane is good. Particularly when you start bringing the fuselage and wing in. So it's -- it's nothing but good news. And it's hard to imagine over time that others won't follow.

Great. And one final quick thing, if I missed this, I apologize. But where do we currently stand on the contracts for the Wolfen Kevlar and bullet-proof vests.

A couple of years ago I talked-a year ago I guess it was I talked about a new government contract for new, lighter-weight vests.

Right. I remember that.

It was delayed and delayed and delayed. It finally was awarded early to middle last year. But the conflict in Iraq and the pace of buying was such that they had to go with the old vests to really get soldiers covered. So the new vests, you know, is still in the process of being developed and approved and checked out. And while some parts of the contract have been awarded, the real volume that is driving this is still the old interceptor vests volume and it's running pretty close to the capacity of the fiber manufacturers. And the order pace would indicate that it will stay there through the year.

Good. Thank you very much.

OK.

And we will go next to Stuart Polterand (ph) of AXIO Capital(ph).

Good morning. I had a question about -- there's a company, I guess, that is marketing a carbon fiber composite core electrical cable and transmission cables and I was wondering whether you're involved in that at all, and if not, you know, do you think that tightens -- if that were successful, could it tighten the market for fiber on the industrial side or if you know about it at all?.

To tell you the truth, I don't know about it at all. But I'm always interested. Send me the contacts. But back to your question on industrial, there are a lot of uses for carbon fiber and there are a lot of ranges of caliber of carbon fiber at the highest end are the very high module high stiffness kind of fibers that go into military aircraft and into a lesser extent commercial aircraft. But then all the way down to the bottom are industrial fibers that go into the oil industry and other such things. We tend to focus and concentrate, and most of our sales come from the high end. So there are a lot of parts of what we don't consider the high advanced end that we don't participate a lot in. And I'm not familiar with that application to know what kind of material we would be going into it but we're not participating in as far as I know.

OK.

I will send you the stuff.

Anything further, sir?

That's it, thanks.

And we will take a follow up from Jason Logue (ph) of Lord Abbott (ph).

Yes, hi. Assuming you're at a revenue run rate getting closer to the high end of your guidance next year and given, if you kind of take out most of the noise that's in your PNO right now and the cost structures, the cost containment that you have done over the last couple of years and rationalization (ph), how comfortable you are, given your high end of the guidance of more break-even type of profitability, if not upside to that?

Well, we haven't given any guidance on that, though we tried to hint pretty hard in the news release that we're setting our sites on getting there and passing right through it. So I just haven't given you a time.

OK.

And gentlemen, there are no further questions. I will turn the conference back over to you for any additional or closing remarks.

I don't have anything really particular to add. Thank you very much for your attention and interest this year. We look forward to sharing our next call with you.

Yes, indeed. Bye.

And that concludes today's conference. We thank you all for your participation. You may now disconnect your phones.