Hexcel Corp (HXL) 2005 Q1 法說會逐字稿

Good day, everyone and welcome to the Hexcel Corporation first quarter 2005 earnings release conference call. With us today are Mr. Steven Forsyth, the Executive Vice President and CFO, and Mr. David Berges, Chairman, CEO, and President. At this time I'd like to turn the call over to Mr. Forsyth. Please go ahead, sir.

Good morning, everyone. Well, might I welcome you to Hexcel Corporation's first quarter 2005 earnings conference call on today, Tuesday April 26. With me today are David Berges, Hexcel's Chairman, CEO, and President and Michael Bacal our Communication and Investor Relations Manager. The purpose of this call is to review our first quarter 2005 earnings release that we distributed last night. As always, we'll 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 related to any forward-looking statements we'll make during the course of this call. Certain statements contained in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments, and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the Company's SEC filings including our 2004 form 10-K as well as today's press release.

Lastly, might I also remind you that 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. Well, with the formalities behind us let me turn the call over to Dave to give an overview and I will return to fill in some of the detail.

Thanks Stephen. As much as I'm coached to be conservative on these calls it's hard not to be excited about our first quarter accomplishments. As you've seen in the release, we continued to see sizable year on year revenue growth hitting a six-year high of over $290 million for the quarter and thanks to good mix and factory performance the incremental sales growth of $27.8 million translated into an additional 11.2 million of gross margin for the quarter. Good cost control helped us deliver almost all of that margin to the bottom line with the operating income of 9.2 million and net income before the refinancing costs of 9.8 million. Operating leverage on the incremental sales was a stunning 33.1% bringing us to a total operating margin rate of 11.3% on sales for the quarter.

We're certainly pleased with our earnings leverage, but the highlight of the quarter was the refinancing of our debt. A watershed event for us. After three and a half years of painful cuts, asset sales, and shareholder dilusion our performance record finally allowed us to refinance our debt to a more appropriate structure. We expect significant interest savings going forward as our weighted interest rate will decline by almost 4 percentage points at the start. We've also extended maturities for 99% of our long-term debt.

As we detailed in news releases and filings and summarized in our March 28, press release, call and tender premiums required to take out our high cost notes made up the largest part of the $40.3 million charge required to complete the refinancing. But going forward almost half of our debt is prepayable. This will allow us to readily pay down debt without penalty as we continue our deleveraging quest.

Now let me comment on the revenue trends by market. Table A in the release has actual sales by market, but since the dollar weakened significantly from the comparison periods, my comments are adjusted for currency to better define real volume changes. In the first quarter FX adjusted commercial aerospace revenues were up about $20 million or almost 18% over last year, thanks to higher OEM build rates a favorable mix of aircraft being produced and growing sales of the new A380 program. The A380 is at the beginning of its year long certification process but a number of planes have already been assembled. A typical configuration may carry 150 more passengers than the 747 and with over 22% of the aircraft weight made of composites it is helping accelerate our participation in the strong cyclical recovery this market is experiencing. Bill rate projections by our customers continued to rise thanks to traffic growth, low cost carrier expansion, and sales of western aircraft to China and now India. The increasing penetration of composites, a newer more fuel efficient designs, leads us to expect a long run of double digit growth in this, our largest segment.

Industrial revenues again showed strength in the quarter up $6 million on a constant currency basis or 7.4% over last year driven by sharp gains in wind energy sales on both annual and a sequential basis. We continued to anticipate significant growth in sales from wind applications going forward, thanks to share gains and the reinstatement of the production tax credit in the U.S. Sales of ballistic reenforcement materials remain strong but down slightly from last year. Constant currency revenues for recreational products and other industrial applications fell 3% this quarter as the availability for carbon fiber for nonaerospace applications continued to tighten. All major fiber suppliers have announced capacity expansions and over time we expect this pressure will ease allowing these markets to grow again. In the meantime, we'd expect our margin mix to stay strong as carbon supply is directed towards higher performance, aerospace applications.

Our currency adjusted sales in space and defense were about $3 million, 6% lower than last year's first quarter due to the loss of revenues from the canceled Comanche helicopter which contributed $3.8 million to last year's quarter. Electronics revenues for the quarter and constant currency were $16.6 million up 5% from last year. Stephen, would you fill in some of the financial details, please?

Thank you, Dave. Well, this morning -- or should I say this afternoon, let me focus on three subjects. The tax provision, earnings per share, and the change in net debt. First of all, you've seen that the tax provision of 3.6 million for the quarter related to earnings from our foreign subsidiaries and did not reflect the tax benefit for the $40.3 million charge we took related to the redemption of debt in the quarter as part of our refinancing. This accounting practice reflects the fact that Hexcel continues to adjust its income tax provision rates to the establishment or release of a noncash valuation allowance attributable to currently generated U.S. and Belgian pretax income or losses.

Now, as you've heard us discuss in the past, while our European operations are profitable and have been so for a number of years, and the majority of tax -- the majority of the tax that you see us provide in our tax provision relate to this European income. Back at the end of 2001, when we established the U.S. valuation allowance, our U.S. operations were incurring tax losses. Now, those losses have diminished as our performance has improved and as some of you will have noted in our recently filed 10-K we were profitable in the United States in 2004. The reduction in interest expense and the continuing improvement in our conditions in our markets will further benefit this improvement trend.

While, as a result of the refinancing charge, we expect that we will have a tax loss for the year of 2005, in the United States, we anticipate that the U.S. operations will be profitable for tax purposes in the remaining three quarters of the year. Despite these improving conditions, we have not yet reached that point where we can satisfy the accounting criteria of the consistency of the improvement in our operations particularly looking back on a trailing basis where we can conclude the time has come to reverse some or all of our valuation allowance. At such time we do make that conclusion, then we'd move back to having a regular provision for taxes on that U.S. income.

So if we look at 2005, we felt it appropriate to give you some guidance as to how to look at our taxes. Our quarterly tax provision in 2005 will continue to predominantly reflect tax on the European pretax income. I should note occasionally you'll see U.S. provision and it relates to certain matters that don't get included in the valuation allowance. The reported global tax provision rate, therefore, will be driven by the ratio of earnings between the United States and Europe on a pretax basis. To help you model, we gave you an indication that you should use a rate on global pretax income in the range of somewhere between 12 and 17% for the remaining quarters of 2005. And that rate simply reflects the weighted average of the income in the United States that has no tax provision and the income in Europe that is taxed at regular rates. Now, given that weighting that estimate is sensitive to changes in the mix of income from the U.S. and Europe, but I think should give you something to start with.

Earnings per share also were a little complicated this quarter so let me talk about that as well. As a result of the refinancing charge, we incurred a loss for the quarter. In such circumstances, we use the -- we can't use the fully diluted share count which concludes for instance, shares issuable under our convertible preferred stock as this would cause our earnings to improve or in other words to be antidilutive. So the rules basically say in such circumstances you use the basic share count which this quarter was an average of 53.9 million in computing EPS for the quarter. Now, in subsequent quarters, if we return to profitability, you'd use the diluted share count provided that using the 94.4 million shares or what the number happens to be in those quarters would not cause an increase in the reported earnings per share.

Now, some investors have asked us, well, how do you look at diluted EPS for the first quarter if you hadven't incurred the charge? So in other words, what would you have earned if you replayed the first quarter without this charge. Well, if you exclude the charge you'll see that net income is 17.9 million compared to 8.1 a year ago. And you would divide that by the 94.4 million outstanding shares and if you do the math, you'd come up with $0.19 per share as an earnings for the quarter.

Now, net debt for the first time in quite a time increased this quarter and I think it's worth spending a moment just going through the components. You'll find all the details in table F and we showed an 82.6 million increase in debt for the quarter. And it's composed of five components, only one of which sort of relates to really ongoing operations. First of all, as we've discussed extensively about half of that cash usage was the impact of the 41.8 million cash costs related to the refinancing of the Company's debt. Secondly, because we replaced our blend of public debt, which paid interest half yearly with the coupon payments with a blend of lower price debt where only about half of it have annual coupon payments, our accrued interest expense reduced in the quarter from about -- by about $9.7 million compared to what it would have been. Hence, if you look at the cash interest expense for the quarter it was 24.3 million which concludes this sort of one off effect to reducing that interest accrual.

Third item that we have this quarter as we've discussed in the past is the recapitalization of our Chinese joint venture and we made a cash investment of $7.5 million increasing our ownership interest from 33 and a third to about 40.5%. The fourth of the sort of nonrecurring items was the actual cash funding of the litigation settlement we entered into last year and accrued for last summer and so we paid $7 million plus a little bit of interest in settlement of that liability. So you take the combination of all of those things, the actual cash usage in the quarter relating to the ongoing business was about $16.6 million and we tend to use cash in the first quarter of each year and this quarter was no different, but this is consistent with the sort of range you've seen us do in the past with primary influences that drive that as growth in working capital as we come off the seasonal lows of December and secondly you have some of the timing and some of the annual payouts of benefits and incentives and interest payments. We would expect that as you've seen us in prior years we will generate cash in the remaining quarters of the year and start chipping away again at our net debt that's outstanding. Well, that sort of concludes my more detailed comments so let me turn the call over to Dave for a few final thoughts before we open it up to questions.

Okay. In summary, we were happy about our ability to support the high yield investors for the last three years, but we're much happier to have the refinancing behind us. As we move from double digit to single digit interest rates, we're particularly pleased to do the reverse on operating margin. Our operating margin income rate of 11.3% of sales was up from 9% last year and 7.5% for the first quarter of '03 and 6% the year before that. With the commercial aerospace cyclical recovery well underway, the secondary penetration of composites and our demonstrated ability to deliver leverage on growth, we feel great about our prospects. Now Steve and I would be delighted to take your questions.

[OPERATOR INSTRUCTIONS] We'll take our first question from Steve Binder with Bear Stearns.

Dave, can you maybe just touch the strong incremental margin performance that you touched on earlier it's being partly driven, I imagine, by the strong growth in the commercial aerospace market as well as wind energy and in light of the fact those are likely to be your two growth drivers going forward, can we start seeing on a more consistent basis this kind of incremental margin performance?

Well, Steve, I think you often compare sequentially which, you know I'm not a big fan of because we have some seasonality that happens. On the year-over-year basis, though, it was also dramatic. I think it's a combination of mix and leverage, so if we can get sales growth in these rich markets for us, I'd expect to see some good increments and expect to see double digits.

And then with respect to -- can you maybe just touch -- you touched on material issues in the quarter but can you just talk about where you're supply constrained I mean, in what areas from a vendor standpoint do you feel supply constrained today?

Well, I think we've talked in the past about aero mid fibers being near capacity in ballistics and that's sort of why you see a flattening out in recent quarters in our sales net segment but in recent quarters carbon fiber supply has become tight. That's both industrial grade and aerospace grade. As you know, when the aerospace market was down, many of us who are capable of making aerospace grade fibers used the capacities to support the industrial markets to keep the plants running. Now that aerospace has snapped back so dramatically it's put some pressure on the system. So you've seen every company involved in the business at least all the major ones announce capacity increases. I expect in time that will relieve itself.

Okay. Thank you.

Yes.

Moving on we'll now hear from John McNulty with CS First Boston.

Hi, guys. Pretty solid quarter across the board. One thing that I did want to dig into a little bit, the space and defense business, I understand it was hurt by the Comanche business drying up, but that said it was still a little bit lighter than, I think, what we would have been looking for even including the Comanche issue in there. So what I'm wondering is, was it just a question of lumpiness just because of the nature of your big customer there or is this something where we may be looking at this as a one to kind of -- or at least low single digit kind of grower looking out for the next few quarters?

Well, John, we are on so many programs that it's really difficult to point to one. The Comanche happened to be pretty big because we were involved in some pretty major tooling projects at the time that it was canceled and of course the first quarter is when that was canceled so the comparisons get easier as we go forward. I think I'd have to attribute it mostly to just timing. It tends to be lumpy as we've said before and I don't think it -- it causes us any particular concern, nor have we changed our guidance in this segment.

Okay. Great. With regard to the capital infusion in your China JV, I'm wondering, is this something we should be expecting going forward or where there that's going to be a continuing area where you'll be sinking more cash and at some point hopefully even maybe taking over entirely or is that a little too early to be thinking about it like that?

It's a rare occurrence for us to put cash into any of our JVs so I wouldn't look at this as a sort of sequential thing. This is a joint venture where we deliberately chose the time it was formed to, finance it, we and the other two parties, with a lot of debt. And as it sort of moved more into its operating mode and we're much more comfortable with it as investors, we concluded that we should sort of reduce the debt to equity ration -- the venture. This is not a venture where we had expressed any plans to buy it in. It's a venture with Boeing and with aviation industries of China. And those are natural partners to be part of this business and so it's not the sort of business that you would necessarily target to own directly.

It's one together with our business in Malaysia that we expect to continue to improve. You've seen them move from a couple of years ago when they started up doing nothing to now beginning to get to much more mature levels of operation. They're almost at break even in terms of their operating profitability. That's why you see the earnings -- equity earnings improving quarter by quarter and with the benefit of higher build rates the rising tide will benefit them too and we would expect to see them move to periods of now, out of the startup to positive cash flow and to greater profit contribution. And that's how we'd envision them moving forward at this point.

Okay. Great. And then one last question on the -- on the 787 platform, I know a while back Torray had won a big slug of the business but certainly you and SyTech are still duking it out for some pretty reasonably large pieces of business there. I'm wondering if you have any color at this point now that we're a little deeper into the developmental stages as to how much or how big of a piece of business you might actually be able to get and if you can share that with us.

John, we prefer not to announce details of any kind of contract or arrangements with our customers so I'm sorry I can't help you out on that. I would say though that as we've said before, any new aircraft has lots and lots of opportunity for all of us in the composites business. The composites penetration is growing with all aircraft that are being designed. That's A350. 787 and the A400M. They tend to declare a certain percentage at the beginning and it tends to grow as they try to wrestle with weight problems. And of course, the sales prospects for the 787 have also -- seem to have improved dramatically so we look forward to the launch of that aircraft.

Thanks a lot for your time.

We'll now here from Howard Rubel with Jefferies and Company.

Thank you very much. A couple of things. Could you talk a little bit about the profitability in the U.S. and what's been the underlying factors that have driven that?

Yes. Why would the U.S. have been in a tax loss situation, certainly. If you look back to sort of 2000 is the start of this story. The U.S. was slightly profitable at that point, but it was where most of our debt was located so historically, in most of the debt in the Company's balance sheet was sitting the United States and very little was in Europe. And as a result the slightest change in demand could push the U.S. into a position of losses. If you look at where did some of the big hits come from in 2001, one part of it was the decline in the avatronics business and we took that impact more significantly here in the United States than we did in Europe, and in fact, we look at the patent of some of our restructuring expenditures also that we incurred to respond to those circumstances, a great proportion of those costs were incurred in the U.S. so if you go back to our 10-K footnotes you'll see some really large U.S. losses in 2001, diminished a bit in 2002 and then a little further in 2003 and in 2004 we finally became profitable.

And what was causing that improvement? Well, one you've got an end to these sort of nonrecurring restructuring costs. Secondly, we were paying down debt as we regenerated cash so the interest burden was shrinking and thirdly, operations with the benefit of restructuring while the volume wasn't up particularly until you get to 2003 we're seeing the benefits of lower costs. You -- by '03 though into '04 you're going to get the benefit first of all with the growth of ballistics which is predominantly a U.S. trend and now as you go from 04 to '05 you're getting growth in commercial aerospace, you got lower costs of debt, both as a result of the refinancing, but also because we are paying down debt and all of those factors combined to getting us back to a more stable level of operation.

In the intervening period we've also taken steps to move some of our debt to Europe so while you can never get these things perfectly balanced, we have more interest expense burden carried by European subsidiaries and that helps too. So those are all the factors that led us to the set of circumstances that we're at today. We now have to satisfy -- it's almost like an more probable than not criteria that before you can address those valuation allowances though and use the deferred tax assets -- it's not that we can't use them, it's you just don't see them on the balance sheet. We have to build the burden of proof predominantly based on actual performance as opposed to perspective performance and collect a few more quarters and then maybe we can move back to regular tax accounting here.

Except no matter what happens, Stephen, you won't be paying U.S. taxes even if you're booking the provision for quite some time so I'm not really --.

Well, that's true. There will be pieces that you pay but, yes, that's true. There are large deferred tax assets and so that could help.

That's -- you talk -- Dave, you talked -- thank you. You talk about the constrained supply of carbon fiber. Are there some things that you can do to enhance your ability to satisfy demand? I mean, for example, you typically have some downtime in the third quarter. You just run the factories at higher rates. So there is some debottleneckings that can go on and -- and I have something after that.

Well, remember, Howard, most of our fiber is designed for the high spec aerospace, particularly the space and defense applications, so our facilities are running around the clock and have been for a number of years, but the mix is now almost entirely aerospace, so the -- the capacity that we -- needs relief to help the recreation and industrial markets is from the industrial players who are trying to get more out of their existing facilities.

So I mean, where I'm trying to go with this and I know you're not going to totally want to answer it but we'll try cat and mouse, is if we still see these double digit growths in commercial aerospace and -- which is great and also mix improved, that's all wonderful, but then you're giving a little bit -- you're not maximizing what could also be there because you're giving up some customers that would like to still buy your product. Is there anything that can be done to sort of prevent these declines that we're seeing in other markets?

Well, we're working pretty hard at that is why you didn't see much of a decline at all in the quarter. I'm hopeful that we can keep up with it as we work with the industrial fiber suppliers. We have prefragging capacity. It's a matter of getting access to industrial supply. Bear in mind also that carbon demand is now increasingly going into the wind energy market, so the biggest wind turbines, a number of our customers are now putting carbon -- integrating carbon as well as glass fibers into their blades, so the demand for carbon continues to rise and I expect that even as -- as everyone adds capacity, we'll see -- we'll see tightening.

Thank you very much for that.

Moving on we'll now hear from Al Kaschalk with Wedbush Morgan.

Good afternoon. Dave, if I may follow on with the previous question, are you then seeing any customer complaints on the lack of ability to supply or is it going to be more of a question strategically moving forward that you're going to focus on more that wind energy markets or and end markets where there's higher demand for certain products that would allow you to gain greater margin?

Well, we're interested in the diversity of all these markets. We clearly have focused more on fewer markets in recent years. But I think it's pretty safe to say fiber availability is -- is something everyone was talking about at the composite show in Paris two weeks ago. A lot of people have come to appreciate the performance that carbon fiber composites can offer and demand is outpacing supply.

And the prepared comments and the press release there was terms about medium turn on the availability of the expansion. Should we view that as 12 to 18 months or how should we be looking at when the availability will come online?

Well, there are a number of suppliers. There are very few who supply to aerospace specifications. There are a bigger number, though, who also support industrial and everybody's got different schedules. I think you'd need to kind of go through all the suppliers to sort of check their press releases on when they come online. I think an important point though that we make in the release and it seems you have all picked up on is for Hexcel, to the extent we are limited on supply, you'll see better mix or more enhanced margin. So you see our sales maybe could have been higher if there was a free flow of industrial carbon fibers, but the margin mix improvement, more than offset that from a bottom line standpoint.

All right. My other questions have been answered. Thank you.

Moving on to Lionel Jolivat with Goldman Sachs.

Good morning. It's a follow up on the previous two questions, but in February you announced a plan to increase your carbon fiber production capacity by 40%. And if I remember well at the time expansion was scheduled primarily for '06 and '07. I was just wondering is it possible to accelerate these plans and to start investing in the traditional production capacity you alluded to earlier, because when I look at your CapEx this quarter it's actually relatively low so it does not seem that you started these investments.

We have started work on design of the facilities. It's a process that takes about two years before you make the first carbon, and then in the case of the highest performing aerospace materials it can take up to a year to get qualified and certified. During that time we likely would be able to sell the fiber into a lower spec industrial applications but the process to bring new capacity on line in the carbon fiber arena is a two to three year process and I think you'll find that with all the carbon suppliers, unless they've got idle facilities that they're starting up.

Okay. And then -- so looking at '05, I think your previous guidance for CapEx was roughly in line with depreciation and amortization which is running around 52 million historically. Is it still the case now, even if you ramp up and your investments in production capacity?

We've not changed our guidance on '05.

Okay. And then last point on -- on the subject, it's clear that it makes sense -- it kind of makes sense for you to -- to provide or to supply your carbon fibers to the aerospace industry versus the industry. Could you give us the margin differential between these two businesses?

I'd rather not, thanks.

Okay. And just last thing. Looking at your EBITDA margin which was up roughly 150 business points year-over-year, I mean, how much of it really comes from mix versus volume and cost containment? I'm just trying to have a sense for the benefits associated with the better mix.

It -- you get a sense of it if you look at the components of change in the -- the income statements. The SG&A line, you've got SG&A up about $1 million, R&D up a little less, so you're obviously consuming some costs from the high level activities there but it's at a lower rate of growth than the rate of growth of sales so most of the incremental EBITDA on a year on year basis is coming from gross margin. We clearly -- you put an extra 10% of volume through our plants. We clearly get the benefit of that because we don't have to add a lot of infrastructure or people to, in effect, sell more of the same products to the same customers, so there's clearly leverage on volume.

I think though when you have a quarter such as this, you've just got to look -- if you look at the incremental changes by sales by markets, most of the incremental volume year on year came out of commercial aerospace and so clearly, you're seeing benefit of the contribution we get on that -- those more technically demanding products that we sell to those markets. You asked earlier, Dave, about the difference between margins, between aerospace, and nonaerospace applications. I would express the question differently. There's a very big difference in technical demand out of our aerospace customers, both in terms of the performance, the product, in a sort of statistical sense here. There's much fewer defects and deviations permissible. In terms of the degree of testing, the amount of record retention and all of those feed into a different economic model, but clearly you see when we have a richer aerospace mix, you see a better margin correlation. So I know I didn't answer the question directly but hopefully gives you some parameters to think about.

No, no. That's perfect. And then last question, regarding the A380 so you're just starting to -- to send the product to Airbus, I mean, what did it represent in terms of sales in the first quarter and how should we think about the -- the production ramp up for the A380 throughout '05?

I'd make two observations. One is that we've been selling to the A380 for quite some time and that, though the run rate in the first quarter is not dissimilar to the run rate certainly in the second half of last year and maybe even earlier than that as we've been feeding -- they're already, I think, there's now five aircraft standing on their own landing gear in terms of that production and assembly operation so there's a lot of stuff in the pipeline. Clearly your production will ramp up as they move towards the phase of starting to deliver aircraft because some point in 2006 this aircraft will be certified and customers want it certified or want their initial orders filled. And so we would expect to see an increase in the level of activity.

I'm afraid, though, from a whole host of reasons we don't don't disclose the individual sales by program in any -- for any quarter for any program so I can't give you the granular detail other than to say it's in there, it was a contributor year on year but the biggest driver to our commercial aerospace revenues are the unit numbers of aircraft anticipatedly built by our customers and hence the current demand in terms of the material supply.

Thank you very much and congratulations again in the quarter.

Thanks.

[OPERATOR INSTRUCTIONS] We'll take a question from Alex Mitchell with Scopist Asset Management.

I just want to ask a few questions. One is in light of what could be a raw material shortage or however you want to characterize it, is there a percentage of your production that could be vulnerable to that, that you would kind of move up -- up maybe to the aerospace side and obviously capture more margin?

Well, we don't break out the detailed submarkets in industrial but it would be down in the industrial segment. We have indicated that ballistics and wind are the biggest in the industrial and it's below that where you find recreational and other miscellaneous applications that use carbon fiber, so it's well less than half of the industrial segment that would feel the pressure, but mind you, that kind of pressure results, I mean, in supply and demand mismatch leads a little bit to price so you might not even see much of a deterioration in the top line.

Right. I was just wondering if you thought that there was enough business to give up to kind of capture higher margin businesses in light of, you know --?

Well, we are not losing business in aerospace. We are meeting our customers' requirements so it's not as if there's a substitution going on there. We're keeping pace with our aerospace customers' needs.

Okay. Can you just walk through as you -- as you -- as these aerospace platforms go into production how does -- how do your orders change as you get closer to the launch date?

Well, existing production, regular running production, we tend to ship about six months before the airplane is delivered. So if you -- if you know what build rates Boeing or Airbus are going to have in the second half of this year, you'd start to see that kind of movement in our sales the first half of this year.

Okay.

With a new aircraft, there's a long development cycle where parts are being made, trials are being run, fenders are being selected, materials are being stockpiled in some cases, parts are being assembled and then tested destructively so it's a very long cycle of gradually increasing sales on a new aircraft. In the case of the A380 it's well underway. It's doing ground tests now. It might fly as soon as this week for the first time and behind that first certification aircraft are five or six others that are required to get full certification and behind that our customers expecting deliveries so we're starting up the serious ramp now of A380 and once we've reached their steady state production, which would be a couple of years from now, we'd probably fall into the six months ahead of build rate model again.

Okay. And I want to ask, in the energy bill currently is there any -- is there any more allowances for wind or special benefits to wind?

I haven't actually checked up on it because it's been to the altar so many times in recent years, I believe it does not have national renewable energy target which is the thing that we'd love to see the most. Instead, many states I think upwards of 17 now have renewable energy targets for their own states, so that's sort of really driving the growth. The production tax credit, which gives installations of renewable energy a 1.8 cent per kilowatt hour credit for a number of years is -- is what's driving the growth in this country again this year.

What is -- what is the growth rate for wind in the U.S. and maybe the rest of the world?

I don't -- I haven't looked at the numbers for the U.S. for last year, but depending on industrial -- is it AWEA -- is that right, Steven?

The American Wind Energy Association.

Yes. I think their projections of growth on an installed kilowatts per year basis has been growing at 30% a year for -- since 1996, I believe. Last year, I believe the numbers are out now and say that the growth was a mere 20%. Mostly because of the -- a terrible year in the U.S. as -- as Congress let the production tax credit expire. They renewed it in September and I understand the backlog has risen dramatically. I read in a trade magazine yesterday that the wind energy turbine manufacturers for the U.S. are sold out for 2005. So I expect it will be a very strong year.

And you're gaining more content on that?

Pardon me?

And you're gaining more content?

Yes, we've discussed in the past that we have won some significant share with the -- with the major manufacturers in Europe.

All right. Thank you.

Moving on we'll now hear from Howard Rubel with Jefferies and Company.

Thank you. I wanted to follow up on the ballistics business which was relatively flat. As you look at customer backlogs, do you feel that this run rate is pretty stable for the foreseeable future, Dave?

They have pretty strong backlogs. I don't know the quality of those backlogs because I'm not really privy to it. There was a lot of -- some might be suspicious that there's some double ordering in the panic of the ramp up for the war, but I believe the backlog as I understand it is pretty strong, and so it should last some period of time. We also have quite a bit of demand that was not being served as the U.S. military was dictating where the supply went.

That's actually fairly encouraging as we think about the way you're going to build your business for the balance of the year.

Right.

Could you talk a little bit about where you are spending your capital and how it's going to help either profitability or volumes?

Well, we always break capital into three or four pieces, one that's sort of maintenance safety kind of capital that we ran through even the -- the weaker periods. Then of course cost reduction capital projects that have what we think are respectable payback and would help expand margins or help us be more competitive or both and then capacity increases. We of course haven't had much in the way of capacity increases in recent years other than wind, but now obviously we're putting a lot more focus on capacity expansion as we see this recovery going forward.

And -- and so the -- this year's spending is how split?

I don't -- don't know that we disclose it.

We haven't disclosed that.

We'll keep on trying. And then last on R&D I mean, it ticked up a little bit and my guess is there's some other exciting projects that are going on. Could you talk a little bit about that? Because it's sort of important to just beyond aerospace.

Well, I think if you just stay in our two prime markets, if you look at the aerospace, the fact that there are three major big airplanes in development, that is the A400M in Europe, the military transport, the A350 and the 787, that drives a lot of -- a lot of activity as people try to find solutions not just for wing skins but for all sorts of parts on the aircraft. Our core -- our honeycomb core business is active and working on floor panels and we have resin systems for infusion and all sorts of specialty weaving and reinforcement technologies that are being explored and developed, so just those three programs would create quite a bit of activity in these arenas, but in wind energy they're also making blades bigger and bigger and trying to incorporate carbon to make them lighter so -- and you've also seen that Bombardier and Hombre Air are involved in new programs as well as a number of smaller aircrafts. So it's an exciting time and we're happy to see the R&D going up.

And then actually the last thing, if we talk about profitability and efficiency, with these higher production rates -- because you're getting longer production runs of a similar material, should that also help with some of the operating leverage we see going forward?

Sure. I mean, that's part of the reason. You see gross margin go up, you would think that gross margin wouldn't move. It is partly mixed but to the extent factories didn't have to add management, gross margins go up as long as we're getting incremental variable margin.

Thank you very much.

Moving on we'll now hear from Jason Loeb with Lord Abbott.

Hi, guys. A couple of questions. The first on -- on the availability of -- of carbon fiber as it relates to the industrial market, and more specifically their recreation. It sounds to me that at least in the short term and going out to 12 months there doesn't seem to be too much capacity coming out online and given that scenario, where are you guys kind of positioning yourselves to continue to address that recreation market even -- and also, even if it makes sense or not to -- to not concentrate on it?

Well, we have some technologies that -- that we've been proposing for a number of years that are starting to become popular. We can take heavy -- heavy bundle, heavy tow industrial fiber and spread it. We have some particularly interesting weave techniques that can make what has been a fiber that was unattractive to some of our customers and it becomes much more attractive when it's the only -- the only way they can make their products, so we don't see -- we don't see an ending in our participation in recreation. We still see it as a great business. I don't think -- I think we're mostly talking about a lack of growth in that market compared to prior years.

Okay. And second of all, given your capacity utilization and production, how much additional volume can you push through your -- your existing plants without making any additional CapEx?

Well, let me answer it this way. To the extent the commercial aerospace, space and defense, and wind energy have increasing demands, we are going to be there and I'm happy to expand with those markets.

Okay. Thanks.

And it looks like we do have a follow-up question from Steve Binder with Bear Stearns.

Dave, just as a follow-up. You answered about capital expenditures but how about with respect to overhead related costs? I mean, are we in an environment today when you look at your indirect related costs and functional overhead costs that they should remain pretty stable and why did the end markets and the way they're evolving here in the next few years or is there going to be some overhead cost creep here.

Well, creep's a bad word. I don't expect to see creep but there are strategic additions for markets. There are strategic additions for -- reducing costs with respect to Sarbanes-Oxley maintenance. So we have regularly added indirect people with unique skills or attributes or in a market that we want to focus on particularly in carbon fiber for instance. What I hope to be able to deliver is productivity and offsets so that we don't end up with creep as you call it. I mean, IT systems improvements and a number of things can improve and offset strategic additions.

So as a percentage of sales we should see continued improvement then?

I always like to see percent of overhead costs percent of sales improving in a growing market.

Thanks a lot.

That is all the time we have for questions today. I'd like to turn the call back over to David Berges for any closing or additional remarks.

I don't have any better comments than that press release. So with that we'll thank you for your time today and look forward to talking to you in the second quarter.

That does conclude today's conference call. I'd like to thank everyone for their participation.