Hexcel Corp (HXL) 2004 Q3 法說會逐字稿

Good day everyone and welcome to the Hexcel Corporation Third Quarter 2004 Earnings Release Conference Call. This call is being recorded. With us today are Mr. Stephen Forsyth, The Executive Vice President and CFO and Mr. David Berges, Chairman, CEO and President. At this time I would like to turn the conference over to Mr. Forsyth. Please go ahead, sir.

Good morning, everyone. Might I welcome you to Hexcel's third quarter 2004 earnings conference call today, October 21. With me are David Berges, Hexcel's Chairman, CEO and President; as well as Michael Bacal, our Communications and Investor Relations Manager. The purpose of today’s call is to review our third 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 that we may make during the course of this call. Certain statements contained in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments and uncertainties caused by a variety of factors that could cause future actual results outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the company's SEC filings including our 2003 10-K and of course today's news release. Lastly, I might also remind you that this call is being record by Hexcel Corporation and is copyrighted material. It cannot be recorded or rebroadcast without our expressed permission. Your participation on this call constitutes your consent to that request. Well, having taken care of the formalities let me turn the call over to Dave.

Thanks Stephen. For the third quarter, we achieved dramatic year-over-year revenue growth driven by the first substantial signs of recovery in commercial aircraft production, continued strength in the sale of ballistic fabrics, and a good quarter for wind energy. Heavy spending on Sarbanes-Oxley, a bad debt reserve and a litigation settlement created some unusual pressures on our results, but we were still able to deliver good operating leverage on the incremental sales. Year-over-year third quarter operating margin was up 62%, which translated to a $7.3 million improvement in net income for our seasonally weakest quarter of the year. For the quarter, sales were up 24% or $50.3 million to $263.1 million. On a constant 2003 currency basis sales would have been $44.4 million higher than the third quarter last year. So we had about a 21% of real growth.

Gross margins were up $15.3 million and as a percent of sales up 230 basis points over last year. Operating income was $18.6 million for the quarter or 7.1% of sales versus 5.4% of sales last year. The slight $2.3 million bad debt provision and a $1.5 million expense for class action settlement. As expected the quarter also had a significant level of effort for Sarbanes-Oxley compliance impacting SG&A versus last year. Depreciation business consolidation and restructuring expenses for the period totaled $13 million down from 13.3 million last year. Increased taxes on our European earnings were more than offset by lower interest cost and improved joint venture performance resulting in net income of $4.3 million.

After the $3.2 million accounting treatment of [deemed] for dividends and accretion net income available to common shareholders was 1.1 million or 3 cents per diluted common share as compared to a loss of 16 cents per share in the third quarter of '03. Revenues as usual were down from the second quarter due to European vacations shut downs but by any other measure it was a quarter of dramatic growth. On a constant currency basis, commercial aerospace revenues for the quarter were up $22.9 million or 25% over last year. Thanks to shipments to support higher OEM billed rates in 2005, a favorable mix of aircrafts being produced and growing sales for the new A380 program.

While a number of airlines struggled with cost, worldwide passenger and freight traffic is clearly on the rise, as are the airbus and Boeing bill rate projections and thus our prospects in this segment. Industrial market revenue showed tremendous strength in the quarter, up $21.8 million or 34.1% in constant currency terms over last year, driven by another strong quarter of ballistic reinforcement sales and increases in our sales for wind energy.

The demand for ballistic materials remains strong with sales up sharply year-over-year but basically it's flat as compared to the second quarter of '04, due to fiber capacity constraints. Wind energy revenues also had strong double digit gains due to continued market growth and new product introductions. The recent passage of the new production tax credits for the wind power in the U.S., should allow for continued growth in the wind segment of our business.

On a constant dollar equivalent sales to space and defense applications were $4.8 million, 4.2 million or 9.3% lower than a strong third quarter last year. The majority of this reductions explained by determination of the Comanche helicopter program, which contributed $4 million to the last year's quarter. The company provides materials to a wide range of military programs and sales tend to vary quarter-by-quarter based on customer order pattern -- ordering pattern and timing and extent of program funding. Other than Comanche there are no signs of softening in this market.

Electronic revenues for the quarter in constant currency were $16.2 million compared to $12.3 million last year and compared to the revenues in the second -- and comparable to the revenues in the second quarter of 2004. The company continues to focus on higher end applications. This focus on advanced technology materials in specialty applications, together with some recovery in industrial demand is contributing to enhanced performance in this business.

In summary Hexcel again delivered solid year-over-year improvement in virtually every financial measurement despite the non-recurring charges we had to take in the quarter. We delivered net income in the third quarter for the first time since 2000 in the third quarter when we just broke even. So our previously stated goal of being profitable every quarter now looks to be a low bar. With a wide spread evidence of the recovery in commercial aircraft production and our confidence in the leverage we can achieve the topline growth we now set our sights on continued earnings expansion. Let me turn the call back over to Stephen for a few details before we open up to questions.

Thank you Dave. Well, let me fill in a few brief details, but I would say this quarter with the strong performance was not much to talk about. First of all net debt as Dave noted, net debt decreased $16.9 million in the quarter to 405.9 million at the end of the quarter. Interest expense for the quarter was 12 million compared to 13.5 million in the third quarter of 2003. Last year refinancing to subsequent continue debt reductions and our interest rates swaps help explain the reduction in both cash and book interest expense.

You will find in table C, on page 14, of the earning release the usual breakdown at components of the quarterly interest expense, and of course table E, provides the details of our outstanding debt capital structure as of September 30. Capital expenditures for the quarter were 8.5 million and year-to-date we now stand at 20.3 million. For those of you follow us closely you will see that’s the increase of the last year's rate, and in fact the trends of the last couple quarters is upward. The more rapid recovery in demand than I think most of us expected at the start of the year has increased our capital expenditure needs, so we now anticipate 2004 capital expenditures will be approximately 36 million or about 6 million higher than the range we gave at the start of the year.

Equity in earnings during the third quarter from our affiliated companies was a breakeven, reflecting the earnings generated by U.S. tax base on that [venture] and the decline in the losses being recorded by our structures joint ventures China and Malaysia. As you recall those two joint ventures are slowly ramping up that production of aerospace composite production and improving their performance at the same time. We -- this was an, performance improvement if you look compared to the last year of approximately $300,000. Well that’s completes management's comments on the third quarter results, if I may return the call to the conference call operator, we will be now happy to respond to your questions.

Thank you, our question and answer session will be conducted electronically. If you do you have a question for our speakers today, you may ask that question by pressing the "*" or asterisk key followed by the digit "1" on your touchtone telephone. If you are joining us with a speaker phone, please release your mute function so your signal may reach our equipment. Once again if you do have a question for our speakers today, please press "*" "1" at this time and we will pause for just a moment. And our first question will come from Steve Binder with Bear Stearns.

Good morning. Just wanted a couple of housekeeping items because I came in late, the charges you took for the bad debt provision and litigation settlement on the consolidating can similarly both and other expense?

Let me answer that Steve. The bad debt provision, the $2.3 million is in SG&A, this so it explains about a third of the year on the exchange there. The 1.5 million, you threw up to the litigation reserve is in the other income expense line just before operating income.

Okay, you know I know that seasonally its your weakest quarter and you know I always like to look at detrimental performance from Q2, Q3, and you know you always have fairly high detrimental margin in that quarter. But it was a little bit higher than it has been in the last three or four years. Can you maybe touch on, its looks like it's kind of like a little over 70% detrimental margin. You had the small decline in sales, can you touch on that, or is it the gross margin line I am looking on?

Yes, it is the gross margin line and comparing what second quarter of--.

Yeah, your profits are down $6.5 million and your sales are down 9 million from Q2, to Q3.

Right. Well I think if you look at it, you know most of the -- this isn’t the gross margin line.

Yeah exactly.

Most of the impact is probably a mix related component. You know when you put less volume through the plant and some of the mix of what you produce, impacts it. I am not sure there is any particular science in what you see in that metric.

It's just a mix issue it is not a performance issue. You didn’t see any plans kind of under performed relative to where you might have anticipated?

No other than the other fact always get at some of those plans and ran shorter periods and with a little kind of European plans in the third quarter than need in the second quarter.

Right, but that’s always the case, that’s why I was asking you know for [worse]. The other thing was operationally inventories and I granted you got inventory built situation here in aerospace right now, but historically at least in the last four years inventory has specifically turned lower in the third or second quarter and they are up pretty sharply this quarter. Is that all aerospace related?

I don’t Steven if its aerospace specific, but this is a pretty dramatic sales growth pace, and if you assume that it wasn’t and then not only in the third quarter we are ramping up pretty hard. So I look at it year-over-year the inventories is up, 10 million with sales up 50. I am pretty comfortable with our own inventory.

What kind of rate are you building out right now for airbus would you say you mentioned four to six monthly time. Would you say you are at that kind of 350 plane level rate now, because they are stepping up their narrow body rates every quarter now going forward. So I am just wondering -- do you have a rough idea where you are at?

I think the ballpark is about five or six months in the case of airbus. So I mean as you watch ourselves go up you kind of get an early warning indicator of what's happening at airbus.

But I mean would you say that’s the kind of build rate you are right now roughly for them that 350 point?

I think the answer is tough to tell. We are certainly seeing subcontractors and some of the [this] locations buy more. Whether you know, what they are taking from is fully reflects the rate they are going to be at, whether it’s a little ahead or a little behind that. You know one quarter is dated, doesn’t really I think give you enough to tell.

I mean, I think its safe to say Steve that it’s a 25% step up and so we are pretty far off the curve to the bill rates that we think we will see next year.

Although they should be further step up dates in not the by the later in '05 for reflecting those, because '06 is going to build as well for them, right?

Yeah, I mean, when you talk about '06 sure that will be some more moves later on, I just mean this is the pretty dramatic step up and you know I don’t think you are going to --

Yeah but for further increases near term you mean?

Not near term right.

Yes. Okay, alright, good, thank you very much.

Sure.

We will now hear a question from Brad Duey (phonetic) with Deutsche Banc.

Hi guys, following up on Steve's questions, so sequentially in the fourth quarter, we should continue to see the strength from the third quarter and commercialized [space] it wasn’t anything specific that made third quarter larger just as a sign of strength is just picking up?

Sometimes we get some funny things that happen in the fourth quarter as people do things with inventory. You know we have the summer shut downs that always makes the third quarter soft, and if you look at our historical pattern the fourth quarter tends not to be much stronger when we think it would be because of more days. So it has a little bit to do it with what kind of inventory they want to build for what's happening in next year. I think the signs are a lot brighter for next year or so. So I think that people have pretty solid fourth quarter in aerospace just because of the pace of ramp up.

Okay and are raw materials affecting it all yet, the price of raw materials?

They are certainly some changes that go on and certain raw material in the case of glass yarn for instance [inaudible] a little bit but generally in electronics and ballistics those kinds of things track through in selling price. With respect to things like oil will not be -- last but it has very little impact on this company. And with respect to carbon fiber we tend to have long-term contracts with our customers that are back-to-back with our suppliers. So we move together.

Right, so following from on Steve's question about the sequential gross margin and, implying that it's not that raw material prices crept on you a little bit?

I wouldn’t say that there is a material change in our margins because of raw material.

Okay. Last question -- actually two more if I could. One is on the share count for the fourth quarter. Can you guys help us out a little bit, use any net income number you want but will the fourth quarter be the same calculations you had in the third quarter on our net income numbers of all things been equal?

Probably not. Let me sort of explain this maybe by reference to the third quarter results. You saw us report 3 cents a share based on 1.1 million of net income attributable to common shareholders. If we had not taken the bad debt reserve or the litigation settlements, you know our net income would have been $3.8 million higher, so in other words it would have been 4.9 million?

Yeah.

At 4.9 million, the convertible third would have been dilutive like it was in the first and second quarter. So in fact the share count you would have used for this quarter would be more in the order of 91.5, 92 million just depending how the treasury method came out.

Okay.

Now the other you thing you have to do when you do that dilutive calculation is add back the deemed preferred so, that 91.5, 92 million of shares is getting divided into the 4.9 million of net income.

Right.

Plus the 3.2. So into 8.1 million, I need to come up with 8 or 9 cents a share.

Right.

And we are not expecting at this point obviously all these were non-recurring items, so if we just replay the performance n the fourth quarter that we have achieved in the third quarter you therefore see a check counted and in back to 91.5, 92 million and then EPS of 8 or 9 cents a share on a fully diluted basis.

Okay thanks and one more question if I may is with regards to your outlook on wind turbines, that outlook include decisions by [west house] already in the market place, with regards to going to the lab technology with new a turbine?

I am not exactly sure what the question is there [Brad]. I would say what we have is pretty significant growth trends. Best power, major customers

Okay.

And new products, that I guess that is what your question is. Generally [west] is using pretty [inaudible] and they are growing pretty well and we have a pretty big participation with them and the PTC delay had an effect of near stalling of American installations.

Right absolutely.

So the growth we saw this year was all the more dramatic in my mind because there was such a hesitation over the lack of installations in the U.S and now PTC back on I think we feel real comfortable about significant growth in wind energy.

I got you. So in other words this cycle looks good from what you see?

Yes sir.

Okay thank you.

And I like to remind our phone audience that if you do have a question for our speakers today please press “*”, “1” at this time. We will now move on to Halil Olshen (phonetic) with Deutsche Banc.

Hi, good morning gentlemen, wanted to get a little more color in terms of the commercial aerospace you make reference to favorable change in mix maybe give a little color in terms of what's going on there?

Well, as you have heard us say before I am sure the newer aircraft they tend to have more composites. Of course the bigger aircrafts have more composites, so as we move up in white bodies and as we move to newer aircraft we get an enhancement in the next sort of naturally as time goes on. Some ask about fuel cost and with that’s going to do and you will hear people like [Ellen Manaly], Boeing and others to say well it hurts the end customers the fact is, the higher the fuel cost more important it is that they have efficient aircrafts tend to press towards, newer generation and less likely to take airplanes out of the desert. So, just in general the mix is improving overtime and I would expect that to continue.

Okay and regarding this customer in the body armor segment, not that close to what's happen there, I understand they have had some problems with their [west] just want to get a sense of what exactly went on their on there and if your product is found on any of those that said they have had problems with?

Yeah, as you observe this is classic customer who had some product warranty issues which I like to just keep to [inaudible] they are still. Having manufacturing west both for civilian and for U.S. military applications as successfully supplying and for sometime. In most of what we felt to discuss some of the same result to every other customer you know the catalog basement here is. How do we provide materials that have gone in to the Vestas that our subject to some of these warranty issues, yes. But you know as we do with all of our customers we are providing materials to our customers' specifications and differently than we deal with any of other customers in this sector.

Right. Am I right to say though that that the problems that, at least I think I have read about with that company deals with the that’s made with the other materials not [teflar] but I guess [xylon]?

Yes, that problems relate to vests that they had exclusively made from [xylon]. Others use [xylon] but they happen to use that exclusively, and so yeah those are the issues they can probably get their arms around.

Thanks Stephen.

My pleasure.

And we will now move on to a question with Charlie Gallic (phonetic) with Jordano Securities (phonetic).

Yes, Good morning. I guess regarding second chance and their your writing off their bad debt, are they totally cut off from buying materials from you guys, or you are filing that?

Well, they filed on Sunday. That’s at the right of the start of the process and I am sure you know more of how these Chapter 11 proceedings work. You know clearly they have to get the debt pronouncing and place or whatever to resume purchases and if they are successful in doing all of that, I am sure we will be comfortable supplying them. But at right at the start of the process, I think it's just too soon to describe what's happening.

Okay. And then talking about your ballistics, being at pretty much full capacity in raw materials being tight do you see the possibility of increasing capacity there or and also is it true that the some of the raw materials are on allocation due to the militaries needs such as spectra, and do you see you know the possibility of increase of the ability of some of the fibers?

Generally I would say all of these fibers are very tight and being controlled to a great extent by the U.S government for military purposes. So they participate in where the fiber goes. And that is true of all of the elements for which the U.S government has the ability to control. So we have been running at the maximum fiber pace now for a number of months. I think three of the [paramount] fiber manufacturers have announced capacity extensions in the order of 10% each as I recall. Those will take some time to come on line.

Okay and then if you could -- this is probably a more of general question on the wind market. How -- can you -- do you ever give a percentage of how big that is in terms of revenue to you guys and what the, what do you see in the future in terms of growth rates?

What we don’t breakout the industrial segment other than the sort of rank, the markets by size, we indicate that the biggest in that market is the ballistics business and second is wind is probably tied for second. So it's a significant part of it and historically the installed mega watts globally, according to published reports been growing at about 30% per year. The fact that the wind mills are getting larger is also significant, but it's been a pretty solid 30% for year trend since the early 90’s.

Okay that’s great thank you.

And I would like to reminder our audience that if do have a question for our speakers, please press "*", "1" at this time. And once again if you do have a question, please press "*", "1" now and we will now hear a question from Jefferies & Company. Brad Ryan (phonetic), please go ahead.

Okay, hello gentlemen, just as your performance has been quite strong and your cash flow is ramped up and your free cash flow is significant? Could you talk a little bit about how you expect to redeploy you free cash flow and the cash balance that has been building? Are there acquisitions that are attractive or what another alternative uses do you plan with your free cash flow?

Well, if you look at on what we've done historically as we feel prudent, we have deployed free cash flow to reduce debts, you know not that we don’t but we did any loan repurchases in the third quarter. But if you look early in the year, in the last year. You know we do -- we have going into the market and purchased the 2009 Senior Subordinated Notes as a way of paying down debt and that certainly remains an option of what we can do without cash flow. In terms of acquisitions, we've not really made any statements of any particular indications I wanted to pursue that at this moment in time. You know we still like to deliver little bit more from where we are. I think is the way we look at our business and that’s why we follow on that net debt metrics so closely in our reporting you know we still like to reduce our leverage further from where we stand today.

Is there a target ratio you would like to achieve?

Not, one that serve publicly states and then I think the truth is when you are in cyclical business like we always you know OEM manufacture commercial military aircraft, your views leverage difference between the peak and the couple of the business cycle.

Okay, very good, thank you.

Thanks Brad.

We will move on now here a question from Charles Stanford (phonetic) with Boston Capital (phonetic).

Hi, you talked a little bit about your experiences with airbus especially with A-380. I was wondering if you could provide a little bit more color on Boeing and what's going on there?

Well their order books seems to be building as well and we are big participants in their growth to A-380 happens to be the newest aircraft that is starting to get into significant production quantities for us and while you haven’t seen the plane fly yet, there is a lot of development work that goes on ahead of it a lot of qualification materials that are sold a lot of equivalent aircrafts parts manufactured. So, it's starting to be material on our sales. That’s why we talked about it. It's not that airbus is in a particularly different positions than Boeing other than they have a new aircraft. It's coming on line and it's giving a multi accelerator effect to our sales?

Are you participating in the 77 program?

That’s quite a ways down the road, but we certainly are very involved with helping with, you know technical applications and wide range of materials for all kinds of applications for the aircraft. It’s a process that is pretty intensive for both companies, probably all companies in materials world. So yeah we are very involved with them but clearly no sales for quite number of quarters.

Oh! Yeah, and I don’t think more investments, I know lots having to invest a fair amount now for the 77 program and I just want to sure where you all were in that process?

Those are tier one partners who have a different relationship than we pretty much are more based on material supplier and we don’t contribute or need to contribute to developmental cost other than the work that we have to do get qualifications on materials.

Okay great thank you very much.

Not the same as an equipment manufacturer or tier one partner.

Alright, thank you very much.

Sure.

And that is all the time we have for today. I would like to appreciate everyone joining us today and have a great day. At this time you may disconnect from our conference.