Hexcel Corp (HXL) 2005 Q3 法說會逐字稿

Welcome to the Hexcel Corporation Third Quarter 2005 Earnings Release Conference Call. This call is being recorded. With us today are Mr. Stephen Forsyth, the EVP and CFO, and Mr. David Berges, Chairman, CEO, and President. At this time, I would like to turn the call over to Mr. Forsyth. Please go ahead.

Good morning everybody and welcome to Hexcel’s Third Quarter 2005 Earnings Conference Call, today, October 25th. With me are Dave Burges, Hexcel’s Chairman, CEO and President, and Michael Bacal, our Communication Investor Relations Manager.

The purpose of the call is, of course, to review our third quarter earnings release 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 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 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 10-K and in today’s earnings release.

Lastly, I’d like to remind you that this call is being recorded 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.

Having taken care of the formalities, let me turn you over to Dave to give an overview, and I’ll return in a little while to fill in some of the details.

Thanks, Stephen.

The Boeing strike and the A380 schedule -- reschedule, caused a bit of a lull in our growth trend, but we demonstrated good operational gains in year-on-year leverage. We also put a significant legal exposure behind us and had a very successful secondary offering in the quarter. While we certainly don’t like the, as reported, $0.17 loss per share, legal settlement and related costs of $17.7 million and the $11.1 million impact of the secondary offering masked what would otherwise have been a $0.21 per share earnings quarter, with very little help from top-line growth. We decided to put the previously disclosed HST and Beck anti-trust cases behind us, mainly because legal costs and management distractions were mounting as trial dates approached and discovery demands accelerated. The August secondary offering moved the ownership of various private equity sponsors down to 26%, improved our public flow, and opened up two Board seats. We’re very happy with the market acceptance of this offering and the quality of our expanded shareholder base.

If you look beyond the impact of those two items, you’ll find we regained some of the operational ground we lost in the last period. Inefficiencies that muted our leverage story in the second quarter improved slightly in July but were back on track in September.

After adjustment for the special items, on $13.5 million year-over-year incremental sales, gross margin was up $3.5 million, operating income up $5 million, and net income up $11.7 million. Good leverage delivered all the way to the bottom-line.

Now let me turn to revenue trends in our significant markets. Table A provides both actual and constant currency sales by market. But let me address sales trends and constant currency to better understand real volume changes.

In the third quarter, despite the strike and the A380 delay, Commercial Aerospace constant currency revenues were up $8.66 million, or 7.4%, over last year, thanks to higher OEM build rates. Because Hexcel delivers raw materials to many levels of the supply chain and many subcontractors worldwide, it’s difficult to estimate the impact of the Boeing and Airbus delays. But with the strength of order rates and global air traffic, we expect solid growth in this segment to continue.

For Hexcel, the big market news of the quarter was the official launch of the Airbus A350. Her projections from Airbus suggest composite utilization will be close to 40% by weight, over 4 times the penetration of the aircraft it will replace. This secular trend of increased composite usage in new aircraft designs, at the expense of metals, provides long-term opportunities far beyond the historical cyclical pattern.

Industrial revenues remain strong in the quarter, up about $300,000 on a constant currency basis, as sales for Wind Energy applications once again offset softness in Ballistics markets. Increased Wind applications are being driven by record installations of wind turbines, coupled with the market share gains at a key customer. Sales of reinforcement fabrics for body armor remain robust in the quarter and were comparable to the second quarter of 2005 but were down from last year. Funding priorities, contract transitions, and civil events program uncertainties make the outlook difficult to predict, but we do not expect that we will return to the 2004 surge levels.

Constant dollar sales to Space and Defense were up $9.1 million, or 21.8% higher than last year’s third quarter, driven by a wide-range of programs in the U.S. and Europe. Of note, was continued strength in the sale of materials for U.S. and European helicopter programs. Additionally, we were pleased with the Defense Acquisition Board’s approval of the V-22 Osprey for full production. The V-22 is a good program for us and future build rate increases is a long-term positive for the Company.

Because of the recent oil shocks and hurricanes, we’ve had a number of questions over possible increases in the cost of input materials and energy costs for operations. We’ve tried in the release to answer your concerns as best we can without giving away too much competitive information. Thankfully, the hurricanes didn’t damage any of our facilities and had minimal effect on a small number of suppliers and customers. Some short-term impact, such as spot buys, inventory positioning, and premium costs were incurred to protect our customers, but are now behind us.

Oil prices have led to some increases in the general market for resins, and we use resins in the manufacture of [indiscernible] brakes. But the effects to date have been minimal. We point out in the release that resin purchases are only about 5% of our total revenues. It is also important to note that our most significant resin requirements involved in the support of long-term aerospace contracts have matching long-term agreements to limit our risks.

As to energy costs for our operations, we certainly have seen increases in the third quarter and expect more in the fourth. But to put it into proportion, we have nowhere near the exposure of companies that manufacture metals, such as aluminum, our principle long-term competitor. Our energy purchases represent less than 3% of total revenues. Of course, we’ve had some added transportation costs due to fuel surcharges. But at the end of the day, we see oil and fuel costs as a headwind that we must overcome, just like health care costs, Sarbanes-Oxley, and other external pressures we face. I might point out that our gross margin of 21.1%, with oil over $60 a barrel, is a full 2 points better than the third quarter of ‘99 when oil was $12 a barrel.

Now, let me turn the call back over to Stephen for some financial details.

Thanks, Dave.

Well, I have a few matters that I’d like to draw your attention to before we open up the call for questions. First of all, I’m sure you’ve all noted the refreshed look and content of our earnings release. We hope it makes it easier to read, while providing more detailed information for those of you who need it. We’ll be interested in receiving any feedback you may wish to share and where you would like to see additional information.

The next subject I would like to touch on briefly is taxes. As many investors are aware, due to historical circumstances, Hexcel, today, has a valuation allowance on its U.S. and Belgium deferred tax assets. And as a result, does not provide for taxes on its U.S. pre-tax income in its income statement. As a result, the tax provision you do see in our income statement is predominantly on European earnings. This provision is lower this quarter than last quarter, as, of course, European earnings are always seasonally affected by the summer vacation period.

Now when will this change? The accounting standards related to taxation require the Company assess the positive and negative evidence as to whether or not it will use its deferred tax assets related to the valuation allowance. At such time as the positive evidence outweighs the negative, the Company will reverse some or all of its valuation allowance and start to apply a full provision on its U.S. pretax earnings. In other words, a statutory rate of [indiscernible] or 35% here in the United States. With U.S. profitability, before special items, showing significant year-on-year improvements, clearly, the positive evidence is building and we will continue to evaluate this each quarter.

The secondary offering was completed during the quarter. As a result, we sold -- our investors sold 16.6 million shares of common stock. 13.2 million of those shares came from a conversion of convertible preferred stock that they held. And as a result, our basic share count increased in the quarter, ending the third quarter with 68.5 million shares outstanding.

Now under the terms of our agreements, Hexcel paid approximately $1 million in transaction costs in connection with the secondary offering, and those costs were reflected in our SG&A expense for the quarter.

As of the result of the conversion of the preferred stock, we were required to accelerate the unamortized accretion and dilution related to the preferred stock. And, as a result, there was a charge of $10.1 million under the accretion and dilution line in the income statement in the quarter.

Now, as we look forward to 2006 in the first quarter, under the terms of the agreement, if our stock remains above $9 a share, which we sorely hope it will, we will fee the mandatory conversion of the convertible preferred stock next March. And at such time, there will be a charge of approximately $12.6 million incurred when that final conversion occurs. Again, that will be a non-cash charge.

Working capital, during the quarter, declined in terms of accounts receivable and payables, as we normally would expect due to the seasonality in the third quarter. The difference this quarter was the inventories did not decline, certainly with the influence of the A380 program and the Boeing strike. Nevertheless, as these matters now recede, we should expect to see inventory up in the fourth quarter.

Lastly, if I could just touch on a change in our presentation of Research and Technology expenses. We have moved certain categories of new program qualification costs that we’ve traditionally recorded in SG&A to the Research and Technology line in the current income statement. Prior periods have been adjusted so that you’re looking at this expense on a consistent basis. It’s noted in Footnote B to the income statement.

With the rising demand for materials and product forms being driven by launches of new component aircraft, like A400, Boeing’s 787 and A350, we felt it was appropriate to group the expenses we made in terms of new product development in one line, and hence we have moved those expenses to the Research and Technology line. And we trust that will give you a sense of the investment we’re making in these important developments as we go forward.

Well, having covered our prepared comments, may I now ask the conference call operator to open the call up for questions.

Thank you very much. [Caller Instructions]. Al Kaschalk, Wedbush Morgan.

Well, we certainly look forward to a clean quarter one of these days, but --

We, too.

In the interim, could you talk just a little bit, I know you had in the prepared remarks what the strike at Boeing and the push-out on the A380, when do we expect that to sort of level off in terms of any of the working capital changes or even revenue growth that maybe would be a little bit stronger in Q4 as a result of those activities?

I don’t believe Airbus or Boeing have made any public pronouncements about exactly how the recovery will take place. We certainly would expect that the inventory would work itself out in the fairly short-term. As for the top-line growth, I’m assuming that it would be spread over 1 to 3 quarters, but until we hear something from Boeing and Airbus, it’s pretty hard for us to quantify. I think the most important thing in my mind is that the demand is still there, so it’s a matter of when, not if.

Okay. Secondly, on the Ballistics side, can -- I know you don’t expect the surges of 2004, as your comments have indicated, but are you seeing any slowdown in demand for materials or what’s your outlook there please?

We don’t project in that market. It’s also a pretty difficult one to sort out. We probably do the same thing you do – read releases from our customers and try to monitor with our suppliers of fiber and discussions with the government what’s going to get the next priority. It’s pretty short cycle business. It doesn’t have the visibility that aerospace does. We don’t give any particular guidance on that.

And then on the V-22, is there any type of production rates you can share with us, as we look down here?

I don’t know that any have been put out. If so, I’ll let Stephen tell me. We’ve been running, I believe, in recent years, at about 11 airplanes a year. And I assume that the rate would go up from there.

Yeah, the -- I think you can find in some of these publications coming out of the Pentagon and others, the current productions in that sort of 10, 12 range on an annual basis. You’ll also see, if you read some of the projections by the companies that are obviously leading these programs, that they would love to see production of this aircraft get into the 30 or 40 aircraft a year range. I don’t think you are going to see a change shorter term, but it’s a platform that all the reports suggest the Armed Services love. It’s a much higher speed deployment than the regular helicopter in terms of inserting forces into the field. It also is able to carry a higher payload, and that’s the real attraction to the Special Forces and to the general forces for this aircraft. So we think it’s going to ramp up. I think, as one sees the [indiscernible] review go forward, you are probably going to get confirmations to the resources available to fund this program. But, clearly, there is a strong level of support among the services for it.

And then finally, and I’ll hop back in queue, on the capacity build-out, are there any updates, things tracking? Looks like Q4 is going to be a major CapEx quarter, as you had indicated in prior quarters. Any updates on the capacity buildup?

Nothing has changed from what we’ve said in the past. We’re doing -- putting in carbon capacity as fast as we can and we’re on track.

Nigel Coe, Deutsche Bank.

Put a bit more color on the impact of the A380 pushback on the quarter, maybe just some rough sense on what the second quarter versus third quarter for the likes of that program? And secondly, if you can give a bit more color as well on the growth in Wind year-on-year? Thanks.

As for the A380, we’ve said before, it’s just way too difficult for us to determine exactly when our materials are being applied to what airplane. We provide to so many suppliers. All I can suggest is you look at the historical second and third quarter to try to nullify some of the seasonality and you’ll see this was a bigger step down than in prior years. So we have to attribute some of that to the strike in the A380, because the top-line demand is certainly still there.

Okay.

Wind Energy, you know the summer typically slows down a little bit in Europe and Wind is predominantly a European business. So compared to last year’s third quarter, we still had good growth. It was enough to offset the step down in Ballistics. That’s about as much color as we normally provide. It’s still a very strong business for us that we expect record year will probably be reported in the installations based on readings that I’ve seen. So we’re still real excited about the prospects.

Okay. And on the cotton fiber, you mentioned that you were going to [indiscernible] up to speed. Do you see that maybe fourth quarter and first quarter would also be impacted in industrial by black plastic polymer industrial and recreational products?

Well, first let me remind you that the fiber we’re putting in place is for the highest-end premium products, like Space and Defense and Commercial Aerospace. So our fiber capacity, which doesn’t come online until 2007, will not have much of a difference at all on the Industrial. Industrial carbon fiber is still tight. I see lots of announcements of capacity increases underway and some that are much shorter cycled than what we have to do. One of the big suppliers, Zoltek, is somebody you might take a look at. Those projections look encouraging, so we hope that at some point in the not too distant future we’ll start to see some relief.

[Operator Instructions]. Steve Levenson, Ryan Beck.

Can you tell us a little bit about what’s going on with the 787, the competition for the other supply contracts that aren’t already filled, and where there might be a place for something like HexMC?

You’ve been reading our brochures.

A little.

There is an enormous amount of work that’s going on there and on all new programs, as is typical with a new program. It’s always exciting for the people in our technology groups who have lots of products that we’ve been working on for years to have a platform on which to introduce it. HexMC is a product that we developed a number of years ago to try to deal with higher volume requirements of the recreation industry, such as carbon fiber bicycles, using that technology, but with aerospace caliber materials is an interesting opportunity to displace additional metal fittings and fixtures and window frames in commercial aerospace. So we’re having discussions. We’re introducing that, along with all of our products, to both Boeing and Airbus to try to avail them to further opportunities to penetrate metals.

If you are going to guess today where the 787 might rank in terms of the amount of content that you have, where would you come out?

I will almost always, certainly in this case, but almost always say, a newer plane will have more than an older plane. That’s just the nature of this secondary penetration of composites. And the growth and the opportunity for composites would probably lead each of my competitors to say the same thing. 787 will almost certainly be our best Boeing plane, as the 777 was before the 787.

Okay. In relation to the mix this quarter, even though there was a strike and the push-out, how did the mix affect your business in terms of your deliveries against the total number of aircraft being built?

I’m not sure I’d say there was any specific mix of facts this quarter in terms of the commercial aircraft. There weren’t so many changes sort of what’s in production. The interesting point at this time of the year is, of course, we’re transitioning as Hexcel from moving -- producing for 2005 production, because we tend to deliver, on average, 6 months ahead of our customers. So now you are exposed to the 2006 production. And so with the net growth feeding through, having in effect lapped 2005 growth in the second quarter, in 2006, you see more Boeing aircraft in the incremental production. ’05, a lot of growth came from Airbus production. Boeing begins to catch up in 2006, so that’s in the there in the mix, but more aircraft can only be good. And so it’s -- we are still living in a very robust and interesting period of development for the industry where unit volumes going up with this cyclical recovery and the secular trend is an unparallel level in terms of the number of new aircraft in development that we’ll use significantly more in our types of products. And we are just trying to chase along and grab as much of it as we can.

The one obvious mix thing, which I’m sure you noticed, Steve, is that the A380, of course, is the newest plane and the biggest plane, ergo the big, big impact from a mix perspective with that delay. But otherwise, as Stephen suggests.

Okay, last item. If you sort of said how much would have come out of inventory and how much more would have gone into revenue, if you sort of ex’ed out the strike, where do you think you’re in the delay? What do you think the gross margin would have come in around?

Inventory or gross margin is your question?

Where the gross margin would have come in, you know, if you ex’ed out the strike and the delay.

You’ve got more volume.

Yeah, well, I don’t know, it’s hard to say. I mean the gross margin, I’m pretty happy with. It’s -- for a third quarter that has all the anomalies of holiday shutdowns and the disruptions of the weather and the oil prices. So I think it’s a 26% incremental gross margin. I think the last 6-quarter averages have been an incremental move of 30’ish or something. Third quarter is always a little bit strange, so I don’t know exactly where it would have come in. But I’m pretty pleased with 26. I think we can do better though.

John McNulty, Credit Suisse First Boston.

Two quick questions. I understand you don’t know in terms of what you’re delivering on the composite side to, say, Airbus or Boeing, as to what specific plane it’s going on, so it may be difficult to know if the A380 business is going directly to that, but have you seen a pickup in your overall demand, say, in the October month at this point that would indicate that either they’re building back on that or the implications for the Boeing strike, you are kind of through them already?

Well, I think September/October are always pretty strong months. And I would expect this year to be no different from the others. You know there is no reason we shouldn’t be back on the track for the increased build rates with A380 layered on top. Discounted a little bit for how many of the count are 737s and other old metal airplanes.

Okay. So it sounds like the ramp-up or there may not be a big game of catch up at this point, but at least you are kind of back to business as normal for an October, given this kind of aerospace strength?

I would assume so.

Yes, I think that’s a fair description. I know it sometimes sounds confusing, but you know you do have, as you know, this issue of they use the same material in more than one aircraft, so the materials we provide to Airbus can be used in multiple platforms. You can’t necessarily differentiate. The other complicated factor is, of course, it’s not one single customer here. It’s many different Airbus or Boeing plants and subcontractors. It’s the cumulative effect across these platforms, so that’s why it seems tricky. I know to investors it may seem confusing that you don’t necessarily know the exact revenues per program, but you’ve got multiple purchases and multiple applications and that complicates the analysis.

Sure. Fair enough. The second question is, on the 787, it’s my understanding Boeing put out, I guess, it’s final configuration details, kind of confirming exactly what the architecture was going to be back, just about a month ago. Having a month to kind of look over those and have your engineers look over them, is there anything that’s different that you weren’t expecting, either positively or negatively, that might impact the content of composites on that particular platform?

I think my experience with new programs is that final -- it keeps getting finalized all the way up until launch. And typically what happens is weight problems emerge, as time goes on, as people get fancier interiors and so forth. So we continuously have requests for the trade studies to give opportunities to remove further weight. So that final structure might have been important for a certain Tier 1 subcontractor, so we’re building tooling and so forth, but I see this as a continuous process for composite companies all the way up until launch.

Okay. But there weren’t any major surprises one way or the other at this point? Is it too early to tell?

No, I wouldn’t say any major surprises. The key elements are going to be composite are -- I think you see what you see with every program, which is the number of composite opportunities expands as time goes by. And so the opportunities are going up, not going down, as they move through these design phases.

Howard Rubel, Jeffries & Company.

A couple of things, Dave. On SG&A, if we back out the costs, they were pretty comparable. And if I remember, in the fourth quarter, you had some incremental Sarbanes-Oxley costs and a few other items like that. Could you just give us a little bit of a look ahead in what you think SG&A is going to play out for the balance of the year?

I would think up from the third quarter, but I expect that, as a percent of sales, we’re going to continue to try to really drive leverage and don’t see any reasons for any radical shifts.

So really shouldn’t it be down from the year ago number for a variety of reasons? I mean, I think there were some unusual items in the year ago number.

I was talking about with respect to the third quarter and I guess I don’t have a comment with last year’s fourth quarter. I’d have to take a look at it. My recollection is it was not a very impressive quarter, so I’ll nod my head with you, but I haven’t done the analysis, so I’m not going to give you a forecast.

Okay. The second thing is, when will we see an answer on the Board seats?

I would hope in the not too distant future. That, of course, is up to the governance committee, but I know they are working diligently on it and we hope to do something before year-end.

What sort of -- well, all right. Talk about working capital for a moment. You hinted that there was, or you indicated there was some excess. Can you sort of ballpark the amount of excess? Was it $10 or $20 million?

Well, inventory should normally come down in the third quarter, and it went up. So I would say if you looked at prior third quarters compared to second quarters, it would give you an indication, and it’s probably, let’s see, I think we’re up almost $6 million, and we shouldn’t be up, so it’s at least $6 million, and the sky is the limit on how much it can come down, I guess. No, no.

As you look forward at -- I mean you have an order book from your customers, and that varies from, anywhere from overnight to probably 6 months out. How does your order book today look versus at the end of the second quarter?

Well, I think we’ve talked about this before. We don’t track backlog per se because it’s not really appropriate for our business. And we almost, in almost all cases, have supply contracts. So if they build it, we supply it. So we look at the Boeing builds by month, by airplane, and we look at the Airbus builds by month, by airplane, and it gives us an indication of what the pulls will be from the subcontractors to those people. So we’re more -- you know, once we’re qualified, we have to supply what they need. We don’t ship to an order and have it go to a warehouse if they don’t need it.

No, I understand that. I mean I’m just trying to understand whether there is any ability to -- you know, on one hand you talked about inventory being down naturally, and then on the other hand, you kind of give us some general indications. What I’m sort of pushing for you is to see whether or not there is some way for you to hardwire it better so that we can get a little more granularity.

On inventory you mean?

Yeah.

I think a days basis is a good way to look at it. I’d like not to see it go up proportionally to sales if we can help it. But I don’t think it has wide swings with sales outlooks.

Two last questions. One on CapEx. Where do you think you probably -- I mean we clearly saw a fairly substantial increase year-on-year in the quarter. Where do you think you are going to end up in terms of CapEx for the year within a little bit?

I don’t think we’ve changed our guidance on that at all, Howard. I believe the last thing we put out was $65 millionish.

$65 to $70 million I think was the last guidance and we are still sticking with that.

Okay, and then the last thing is, you talked about market share increases in Wind. Could you help us a little bit in terms of being -- quantify it in some fashion or talk about maybe the number of installations year-on-year that are up versus where you were a year ago?

I think we first talked about a significant share gain with a customer last fall, fourth quarter, my recollection. We don’t normally talk about the specific orders or specific customers, but it was significant enough that we thought it appropriate to point it out. So we have a lapping that will take place probably in the fourth quarter and then we’ll be back to riding the growth of the industry. I think the publications that I see on the industry suggest this will be a record installation year. It’s going on worldwide, but it’s particularly aided by the resurgence of the American market post production tax credit extension. As you recall, we had a year where it lapsed and the people who install turbines in the U.S. pay very close attention to that. So there is a very strong installation pace going on in the U.S. So I’m pretty sure this will be a record year and would hope that we’d see continued growth in the future. This year is probably an extraordinary growth picture for Hexcel.

[Caller Instructions]. Steve Binder, Bear Stearns.

Can you just follow up on the working capital question, specifically that inventories -- you touched on the fact that they were up and they are typically down in the third quarter. Is the increase totally driven by the Boeing strike and the A380 program or are there other factors contributing to that bump?

I suppose we are not precise enough to be able to tie it down to that, since I can’t tell you even what the sales impact was of those delays. I know we did have some spot buy activity to make sure that we would keep our fiber lines running full pace through the hurricane threats. And, generally, in this market, if you have an opportunity to buy industrial fiber, you buy it and sort out where it goes later. So there have been a couple of other little things, but I think principally it was the lull in aerospace shipments.

Have you seen that in the month of October, as inventories to drift lower? Because it should be down in the fourth quarter, shouldn’t it?

I would expect it to be down in the fourth quarter.

All right, with respect to, you touched on the incremental margin performance. You know, you touched on some of the issues back in the second quarter. You had some labor productivity issues that kind of dragged down the incremental margins. Obviously, there are a lot of moving pieces here, but with just looking at labor productivity, how would you calibrate it today compared to the second quarter and is there still room for improvement in that area, especially from a learning curve standpoint, as you are ramped up here?

Yes, I’ve got budget reviews with my businesses this afternoon. And tomorrow, I can’t dare let them hear there is not upside potential in margins. I would say learning curve is not probably the appropriate characterization for our business because we’re just running process lines, oversimplifying. So it’s less learning curve for us and more adding shifts or dealing with demands that maybe outpaced our expectations. So we had, I think we mentioned last quarter, difficulty in starting up new shifts, starting -- ramping up in premium overtime and shipments to meet a demand that was greater than what we expected in the second quarter. Those things have begun to get worked out. I had mentioned in the release, or in my comments, that July was better than the second quarter but still not where it needed to be. August was a little bit better. September looked pretty good. So I think we’re back on track. So we ended up with sort of a mix for the quarter, and I’ll expect that we’ll have a better looking fourth quarter.

[Edwin Griffin], [Black Rock].

Just a quick question, following up on the CapEx of $65 to $70 million. You know you mentioned that this capacity wouldn’t be up and running until ’07. I was just wondering, are there going to be any material operating costs associated with this capacity expansion in the meantime in ’06?

There will be some qualification costs, but those are in ’07.

Okay. So aside from CapEx, no increase in operating costs associated with that expansion?

No. If you look at ’06, you wouldn’t expect really any material change in operating costs. The cost of the expansion, while you are still building the actual hard assets, is capitalized. In 2007, if you look sequentially at events, as the capacity comes online, the first thing you are going to see is, of course, you are going to pick up the incremental depreciation. There will be some incremental operating costs, but this is added to existing capacity, so I don’t expect that to be sort of some large fixed step change in costs. The depreciation is a step change. Our plan is that we’ll start running those assets and we will sell initially to non-aerospace applications where we can, so we will get incremental revenues to amortize some of those costs. But then we’ll have the cost of certification and qualification during that period, as we get the aerospace certifications in place. And so those will be something that will be evident to the income statement and we’ll identify them at the time. But that will be the foundation for them being able to sell, obviously, the better priced materials for aerospace applications once that’s finished.

Yeah, okay, so an ‘07 event.

So no sudden event –

No, no --

-- and really all ‘07 effects. By the time we get you to ’07, we’ll help you through the steps, which will be much clearer by that point in time.

Okay. And then just -- I remember you guys had a slide on your presentation that actually demonstrated your growth relative to commercial aerospace production.

Right.

I want to say it was you outperformed by 10%. I was just wondering, going forward, is there any reason -- do you see any change in that sort of, I guess, correlation or out performance?

Well, your recollection is correct, and just for the other listeners, if you take our 10-Ks each year and do some calculations, such as excluding Space and send sales to Airbus and Boeing, dividing it by airplane builds, offset by 6 months, also excluding our structures business, which is not a materials business but an assembly business, you end up with sort of average per airplane track that you can look at back -- I think it did it back to ’99, and it suggests a 10% growth per airplane per year. I don’t know any reason why that would slow in the future. If you think about the penetrations of composites moving from 6% to 12% and suddenly jumping up to 23% on the A380, or 50% on the 787, or 40% on the A350, as those airplanes start to become a serious part of the mix, I would think that you would find at least that kind of penetration, but that’s out a couple of years.

Okay, and just a follow-up on a previous question, just with regards to aerospace. I think you said that, maybe I misunderstood this, but I think you said in October that you expected, I guess, revenue growth back to normal expectations. So are you implying that the A380 and the Boeing strike issues are behind us? I just -- that was just a little unclear.

I’m not sure what normal expectations are, so I can’t answer on that, but what I suggested was that September and October are always strong months. The strike is clearly over. At what pace those builds get feathered back into the build schedule and how it affects us is no clearer to us than how much the delay impacted us. The A380 though, I haven’t seen Airbus move their delivery schedule of the first commercial to the fleet. I think they are currently saying the end of 2006, and I believe that’s held for a while. So you’ve got to expect that we get back on the previously planned ramp-up to be able to meet the customer demand. I saw a quote from John Leahy, their top sales person, that he could sell more if he could get the slots. So we’re encouraged to see news like that.

Yeah, okay. I mean the last couple of quarters, aerospace revenue growth, mostly over 20%, so I was just trying to understand when we saw that type of growth again. If you thought that was -- should occur in the fourth quarter or is that more first or second quarter?

Well, we haven’t given any guidance, but you are certainly correct to observe that the last 3 or 4 quarters have been extraordinary growth, as we’ve stepped up.

Right. Okay, last question. Just on the tax rate. Talking about going forward in the U.S., a 35% tax rate. Just wonder on a blended basis what your expectations for taxes would be, or tax rate?

The answer to that question is we will probably provide more detailed guidance at such time as we do the reverse when we have all of the facts, because it depends on how that reversal occurs. But if you were to sort of try to do your own pro forma, so if you went and took the second quarter 10-Q, and in the 10-Q, you’ll see we provide each quarter a division between U.S. income and European income, you know what the provision is, and the footnote shows the provision on European income, if you did 35% on U.S. pretax earnings, based on that table, you’d end up with a tax rate probably somewhere between 35% and 40%. So that is sort of like one indicator. But the truth is that we need, once we get these things resolved, to get -- to provide everybody some more detailed guidance at the time, but you know we get a final answer on reversing the valuation allowance.

At this time, we have no questions in the queue. I will now turn the conference back over to Mr. David Berges for any closing or additional remarks.

Okay. Thank you, everyone. We appreciate your support through the confusing quarter. Sorry for all the noise. We hope to give you some clear sailing in the future. Thank you very much.

Thank you. Bye.

And that does conclude our conference call. Thank you for joining us today.