Hexcel Corp (HXL) 2005 Q2 法說會逐字稿

Good day, everyone and welcome to the Hexcel Corporation second 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.

Good morning, everybody. Might I welcome you to Hexcel Corporation's second quarter 2005 earnings conference call on today, July 26th, 2005. With me today as usual are Mr. David Berges, Hexcel's Chairman, CEO, and President; as well as Michael Bacal, our Communication and Investor Relations Manager. It goes without saying that the purpose of today’s call is to review our second quarter 2005 earnings release distributed last night. As always, we'll be happy to take your questions at the end of our prepared remarks.

However, before beginning, let me cover the formalities. First, I would like to remind everybody about the Safe Harbor provisions related to any forward-looking statements we may make during the course of this call. Certain statements contained in this call may constitute forward-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 2004 form 10-K and, of course, today's press release.

Lastly, might I also remind you that this call is being recorded by Hexcel Corporation and is our copyrighted material. It cannot be recorded or rebroadcast without our express 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 to give an overview and I will return a little later to fill in some of the details.

Thanks Stephen. As you have seen in our release, the second quarter was another strong one. Hopefully, the numbers speak for themselves: sales up 14.4% with operating income up almost 43%. Net income of $26.2 million was almost triple last year, and diluted EPS of $0.28 was up 180% from last year.

A look at the incremental performance again demonstrates good leverage on fixed costs. Sales grew by $39.1 million compared to the second quarter of 2004, which resulted in an additional $9.1 million of gross margin, while operating income increased by $11 million or $8.6 million excluding other income and expenses.

The quarter’s operating income margin was 11.9% of sales, versus 11.3% in the first quarter and 9.5% in the second quarter of last year. In fact, the last time we earned this rate of operating income was 1998 when large commercial aircraft production levels were much higher than they are today.

Now let me turn to revenue trends in our significant markets. As usual, table A in the release provides actual sales by market, but I will address sales trends adjusted to constant currency to better define real volume changes. In the second quarter commercial aerospace revenues in constant currency were up about $28 million or almost 25% over last year thanks to higher OEM build rates and favorable mix of aircraft being produced.

I am sure you have read that Airbus has announced a two to six-month delay in the initial deliveries of the A-380 aircraft but meanwhile, Boeing and Airbus have announced increases in their production of other aircraft for 2006 and 2007. Since Hexcel ships its products on average six months prior to the OEMs delivery, we are now starting to see the benefits of this ramp up, and we expect to continue our year-on-year growth trend in the second half.

Last month’s Paris air show was one of the most positive in many years, demonstrating both strength of commercial aerospace market recovery and the secular trend in the penetration of composite materials. For Hexcel, the most encouraging information related to order announcements for new aircraft where the order announcements for new aircraft that will contain many more times the composite content of the aircraft they replace.

Airbus announced additional orders for the A-380 Super Jumbo and Boeing continued to demonstrate that the new 787 will be one of the most successful aircraft launches of all time, thanks in part to being over 50% composites.

The A-350, Airbus’ proposed new offering to compete with the 787 also received significant expressions of customer interest.

Our industrial market revenues again showed strength in the quarter, up about $4 million on a constant currency basis, or 4% over last year, driven by significant increases in sales for wind energy applications, a trend that we expect to continue due to growth in global wind turbine demand and share gains with major customers made last year.

Sales of reinforcement materials for body armor remained robust during the quarter and were up sequentially, but were down from last year’s record levels in the second quarter of 2004, in large part due to Second Chance Body Armor, a customer who filed for Chapter 11 protection last October. As we have noted in the release, aggregate revenues for the other industrial applications were modestly lower in the same quarter of last year.

Our currency adjusted sales for space and defense applications were about $4 million, or 7% higher than last year’s second quarter and electronics revenues for the quarter in constant currency were $15.2 million, down 2% from last year.

Now let me turn the call back over to Stephen to make some final details.

Thanks, Dave. Well let me be brief and discuss three subjects: the tax provision, other income expense, and the changes in net debt. First of all, taxes. As in prior quarters, the tax provision of $3.6 million in the quarter primarily related to the earnings of our foreign subsidiaries in Europe. This accounting reflects the fact that Hexcel continues to adjust its tax provision rate with the establishment or release of a non-cash valuation allowance attributable to currently generated U.S. and Belgium pre-tax income and losses.

As you have heard us discuss in the past, in light of the valuation allowance on our U.S. and Belgium deferred tax assets, we primarily provide for taxes and the profits of our European operations. We adjust our valuation allowance for taxes on U.S. operated profits. When we reach the point where we can satisfy the accounting criteria through some or all of the valuation allowance, we will begin to reflect a provision for U.S. operating profits and you will see our total tax provision return to a more regularized tax provision rate.

Other income and expense, well during the quarter there were several one-off items that modestly affected our performance. For this year’s quarter, the other income expense line in operating income included $1.4 million from the gain of a sale of some assets, and $0.5 million from an accrual related to certain legal matters.

Last year in the comparable period, we had a $4 million gain on the sale of assets and an accrual for $5.5 million related to legal matters. In addition, this year’s quarter we established as part of our SG&A expense a reserve of $600,000 against the remaining receivables the Company has with Second Chance Body Armor, a ballistics customer who filed Chapter 11 in October of last year.

Lastly, it is just worth noting that with the benefit of lower exchange rates our depreciation in the quarter was down to $11.8 million compared to $13.2 million last year and business consolidation restructuring expenses continue to decline, coming in $400,000 for this quarter compared to $900,000 in the same period last year.

Lastly, debt. You have all of the details of our debt capital structure in table G, and net of cash our debt decreased by $22 million for the quarter, resulting in net debt of $434.8 million outstanding at the end of the period.

Interest expense for the quarter was just $7.4 million compared to $11.9 million in the first quarter of 2004 and also, for that matter, in the first quarter of 2005. The reduction in interest expense resulted from our previously announced debt refinancing, and met the anticipated savings of about $4 million per quarter that we projected at the time.

You will also note that with our new bank facility we have started to operate with lower cash balances than in 2004, further contributing to our interest expense reductions by reducing the total amount of debt outstanding on which we have to pay interest.

Well with those comments, Dave and I would now be happy to take your questions.

Thank you. (Operator instructions) We will go first to Steve Levenson of Ryan Beck.

Good morning, David, Stephen or Michael. I was just curious if you can break out any detail on how your revenue was affected by the increase in build rates at the big commercial manufacturers and how much of that was affected by the mix?

I don’t think we actually track that kind of detail nor do we disclose it, Steven but I would remind you that in addition to build rates we have a move toward more efficient aircraft. As fuel costs have gone up, the sales of the more modern aircraft are really what is driving the order book now. I think with low-cost carriers trying to go to all common new fleet and the good sales of 777 and other more modern aircraft.

And on top of that, of course, we do have the production readiness build-up for the A-380. Despite the delay, there are still quite a number of A-380s that have been built for certification and so that is layered on top of any delivery schedules that you have actually seen out of Boeing and Airbus.

Okay, thanks and lastly, I know the A-350 is not officially announced yet, but have you heard anything about composite content in that aircraft?

I have seen numbers that range from 30-40% and I would say, as will all new aircraft, the final percentage won’t be known until it lifts off. They tend to start with a number and then it grows over time as they try to meet weight bogeys or as new materials are introduced and developed for different parts of the aircraft. So it will be pretty significant, in any case.

Okay, thanks very much.

Sure, thanks.

We will go next to Howard Rubel, Jefferies.

Thank you, good afternoon gentlemen. Two things. One is, could we just go back to the 380 for a moment? There was up to a six-month delay according to Airbus and you are building ahead a little bit. How are you able to sort of work through that?

Well we supply materials to a wide, wide range of Tier 1, Tier 2, Tier 3 for any aircraft, particularly one this large. So it is pretty difficult to actually track the exact impact of that. I think mostly it is a matter of responding to pulls from our many, many customers. We just assume it is going to slow the incremental growth of the A-380 on top of the base load, but the base load is growing at the same time so we feel pretty confident that we will continue to show good growth in this market.

Let me make sure I understand that, Dave. In other words, the ramp won’t happen but there is just going to be this core level of demand that will run for a while, and then it should then – rather than there was a build-up that has to be worked off, it is more a case of it is just the ramp is postponed a little bit?

I don’t really know what it will look like Howard, but I imagine because there are so many players and so many different inventory positions through the chain that the ramp will just be a little less pronounced as these things work through, as some suppliers or some tier players will likely catch up and others who did not need to catch up will delay their purchases.

So I still think we will see A-380 sales of substance in the second half, but the base line rate increases that are announced for 2006 will start to impact our sales in the second half, despite the A-380 delay.

I understand, that is helpful. And then you have indicated you are accelerating your capital spending and we really haven’t seen it yet with these numbers here in the quarter. Is it a fourth quarter item, or is it a little sooner than that where we really start to see an acceleration of CapEx?

Unfortunately if you look at our history, my guess is you will find that we always are back end loaded versus front end, just from the budgeting and approval process. Most industrial companies, I would say. But the big spending is of course the carbon fiber expansion. We are trying to accelerate that and increase the capacity that we will put out, so you will start to see sort of a steady climb, I would think, over the next six quarters.

Thank you very much.

Next is Lionel Jolivot of Goldman Sachs.

Good morning and congratulations on the numbers. First, I mean we talked a little bit about the Airbus 350, TDS, 380, let’s talk about the 787. Has any additional work from the composite side been awarded on this aircraft during the quarter? Have you made any progress on this project during the quarter?

I would say we have made a lot of progress, but awards in the raw material world are a bit of a misnomer. Where equipment selections are made and companies go about major development programs with the equipment, in the raw material world it tends to be more defining of what the optimum spec is. People providing numerous materials for trial and error and then a long qualification process, until the material has met all the specifications plus the manufacturing producability trials and the aircraft has been qualified, there really is no way a formal award could even take place.

There can be indications, you can have indications that you are likely to be the provider of certain materials, but it is way too early for anyone to be declaring that they have a lock on any material on that aircraft.

Okay, that is fair. And then looking at the working capital during the quarter, working capital was a use of $15 million of cash and it seems that would see an increase, relatively nicely, while payables came down during the quarter. What happened? Is it just the ramp-up in production at some of your OEMs? What exactly is happening on the working capital side and where do you see working capital for the rest of the year?

Well I think you would see receivables and payables tend to track pretty closely over time with sales and with top line growth. I think we have made some good progress on managing inventories this quarter. We are up a little bit year-over-year but we are down year-to-date, we are down in the quarter despite the growth. So we are pretty pleased with the progress on working capital.

Okay, and last question on the debt side. You paid down $40 million under the term loan this quarter, as you will generate very likely some free cash flow going forward, the plan is still to pay down the term loan? That is the first part of the question.

The second part, have you paid down any additional debt under the term loan since the end of the quarter?

Well two things. Obviously yes, the reason that we put a bank financing in place is to simplify the process of prepayability of debt and so the logical thing at such time as we have free cash will be to pay down the term loan and the revolver facility gives us the flexibility to manage any day-to-day swings in usage.

I think the other thing you have seen through this quarter and we will keep working at it is squeezing the amount of cash balances we have in the system, because that cuts the cost to carry that term debt too.

So our plan would be to continue to pay down debt when the cash is available. Have we paid down any more in the near term? No, we haven’t. It is as it is at the moment.

Okay, thank you very much.

(Operator instructions) We will go next to Al Kaschalk; Wedbush Morgan.

Hi Dave and Stephen.

Hi.

On the wind energy side, a lot of discussion that production capacity is tight and therefore your demand is strong for material. If I recall correctly, the PTC was a one-year type of grant back in November? If that is the case, how does that change your outlook on that business in terms of demand? Secondly, I am sure the Energy Bill helps in terms of looking out for your demand going forward.

I would say that most of the growth of the last five to seven years has been out of Europe from renewable energy targets and green movements and the like. The U.S. has become a more significant player, but the potential is certainly higher in the U.S. because of the low penetration of renewables in this country.

The PTC has been off again, on again throughout the period, so the growth that you have seen over the years is despite the interruption of the PTC, one might say. I think it definitely had an impact on last year as it had expired and I think its renewal for a year is creating a bit of a frantic pace of inflation this year as people are trying to get installations in before the year is up.

I am of the belief that long-term renewable energy targets worldwide and general efficiency gains of wind energy in particular will continue to provide strong opportunity for us and for anyone else in this business. The Energy Bill, unless you have some news that I don’t have, isn’t passed yet and it is anybody’s guess as to if it will go through and what will be in it.

Yesterday my information was that there was a three-year PTC extension built into it and that that had widespread support; and there also were renewable energy targets, federally mandated renewable energy targets proposed. I believe I heard that last night, the renewable portion of that failed. But until it is done, I think all we can do is just keep supporting the growth that the rest of the world is providing.

That is helpful. My other question has been answered. Thank you.

Sure, thanks.

Shelley Lombard; [Inaudible] Credit.

Good morning. Most of my questions have been answered, but one question. Refresh my memory, the other income line, it wasn’t this quarter – I’m sorry, the non-operating expense line, it wasn’t this quarter but it was last quarter so it shows up in the six-month total. It is a relatively large number, that $40.9 million. What is that?

In the first quarter of this year we refinanced all of our debt –

Okay, so those are the fees, the write-off –

It is the write-off of prior financing fees, unamortized capitalized financing fees. It is also the tender and call premiums we paid in the period for calling or tendering for our public debt that we refinanced.

Okay, all right. That’s it. Thank you.

Okay.

We will go next to Edmund Griffin, of Black Rock.

Yes, thank you. Just a follow-up question on the Boeing 787. What opportunities are left on that plane and how meaningful do you expect that plane to be in relation to some of the other platforms that you guys have exposure to?

I would say almost everything still remains on the plane. We do core for floor panels, we do floor panels, we do secondary structures and pre-frags and materials for replacing of fixed components, lightening strike protection. There are tens of applications and materials that are being explored and reviewed and tested and/or qualified. That plane will be very significant for all of us in the composite business. It is just the nature of the penetration of composites. New aircraft will always be better than the older aircraft, if recent history repeats itself.

Okay. And then your comments regarding commercial aerospace sales, saying that you expect it to continue in the second half. So are you implying this 25% top line in commercial aero should continue throughout the second half?

We only have indicated in the release that we expect growth in the second half, despite the A-380 delay. We have not put a number on what the increase will be.

Okay. And then lastly, your comments regarding your short carbon fibers within industrials segment, can you just talk to us about your capacity? I know you have plans to increase your carbon fiber capacity, but given your capacity right now, how that affects your mix and how we should think about that with regard to margins, as well? How much moving around you can use the fiber for, instead of industrial move it to aerospace?

Well our fiber tends to be the highest end premium application kind of fiber. We purchase most of the fiber that goes into the industrial market. All of the major industrial fiber suppliers, in fact all of the aerospace fiber suppliers have announced various forms of expansions or increases. So we expect that at some point this will start to relieve itself.

Our fiber tends to end up in aerospace, particularly military aerospace. So the expansions you have seen from us are almost entirely focused on aerospace applications and we also purchase a lot of fiber. So it is a bit of a mix.

So you are actually – I guess your purchases, your suppliers that supply fiber for industrials, they are actually short?

Pretty much the whole industry is tight because of the recovery.

And how much capacity do you guys have left within, I guess for your fiber capacity for aerospace?

We try to run our fiber lines at full capacity all the time, it is a question of what market they are sold into. As to your question of mix, you should tend to see, if aerospace continues to grow, and industrial doesn’t proportionally, we would expect our mix to be enhanced.

Okay. Are you at all concerned about not having capacity for the expected growth within aerospace and the timing of your capacity expansion?

We are doing whatever it takes to make sure we support our customers, particularly those in our focus markets like wind and commercial aerospace.

Okay, so in the upcoming quarters, is there the potential that you could make a comment that you don’t have the capacity needed within aerospace, or is that --?

That is not a position that I plan to be in.

Okay, great. Thank you.

Having no further questions at this time, we will conclude today’s conference. Thank you for your participation. You may disconnect at this time.