Hexcel Corp (HXL) 2007 Q2 法說會逐字稿

Good day and welcome to the Hexcel Corporation second quarter earnings conference call. As a reminder, today's conference is being recorded. For opening remarks and introductions I will now turn the call over to Wayne Pensky, Chief Financial Officer. Please go ahead.

Good morning everyone. Welcome to Hexcel Corporation's 2007 second quarter conference call on July 24, 2007. Before beginning let me cover the formalities. First, I want remind everyone 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 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 2006 10-K and today's press release.

Lastly, 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.

With me today are David Berges, Hexcel's Chairman and CEO; and Michael Bacal, our Communications and Investor Relations Manager. The purpose of this call is to review our second quarter results detailed in our press release last night. First, Dave will cover the highlights, then I will cover some of the financial details, and we will all then take your questions. Let me hand the call over to Dave.

First, I will focus on continuing operations, and then we will have Wayne provide some details, as well as cover discontinued operations, which now includes the U.S. electronics, ballistics and general industrial reinforcement productlines, what we call EBGI.

On the top line the second quarter looked a lot like last quarter with double-digit decline in Airbus masking a very strong commercial aerospace growth elsewhere. Sales of $289.8 million were up only 3% from last year when you factor in the changes in currency. But it was a quarter of a great deal of operational activity and positioning necessary for the surge to come.

Gross margins for the quarter increased to over $70 million or 24.3 percent of sales, on track with our margin targets for the year, as was our operating margin of $34.0 million or 11.7 percent of sales.

Our diluted EPS for the continuing operations was $0.18 per share for the quarter as compared to $0.15 for the first quarter, and $0.19 for the second quarter of last year, with about $0.01 attributable to the quarter's higher effective tax rate.

For a lot more detail and understanding of the revenue trends, I will cover the growth rates in constant currency since the dollar was almost 8% weaker than the euro versus last year at this time. It is important to note that while the weak dollar sales result in some of our sales translating into larger dollar amounts, it does not help our overall bottom line. As you know, we do hedge our exposure in layers. And while we do not expect the weak dollar to impact our profitability guidance for this year, if it continues to weaken it will be a headwind for next year and beyond.

Commercial aerospace sales were $154.7 million, up 7.4% in constant currency from last year. A380 shipments were again down from the strong first-half ramp up rate last year. While we don't expect the A380 sales to recover until 2008, the issue will become less prominent as sales in the second half of 2006 were also negatively affected by the A380 push out.

However, we still have much stronger demand than expected in the quarter due to sales to non-Airbus customers. Sales to Boeing and subcontractors, engine and the cell makers, as well as regional and business aircraft OEMs were up over 25% in aggregate for the second quarter in a row.

When the ramp up of the 787 beginning, and the A380 to come, our operational focus is to hire and train and qualify our new capacity as quickly as possible. We also continued to invest in the development of new products and the qualification requirements for the new 747-8, the A350 XWB, and the next derivatives of the 787. In the quarter our R&T expenses increased by over $1 million as compared to last year, with much of that increase related to our efforts to qualify XMC materials and products in our engineered products business.

We're very encouraged at the year-to-date order pace for new aircraft. For the first half of 2007 Boeing and Airbus combined have now reported over 1200 orders, with a particularly strong showing for new composite rich designs.

Overall reported sales for our industrial markets were actually down 5% in constant currency. The continuing bright spot remains the wind energy market. In constant currency wind energy's -- wind revenues grew in the midteens rate for the quarter, in line with our guidance, but might even have been higher had the widely reported component supply issues not occurred at our customers. We continue to expect solid growth in the wind sector despite these lingering supply issues, and expect to join our customers in adding capacity in China next year.

Sales for recreation and other industrial applications were lower than a very strong second quarter last year. An exceptionally warm European ski season hurt our winter recreation products there, and in the U.S. the aerospace surge commanded much of our capacity. We are also narrowing our focus related to a number of customers we list in our other industrial sub segment.

Reported sales to space and defense markets were only up 3% in constant currency, but when combined with the unusually strong 15% last quarter, it brings us to 9% year-to-date constant currency growth from last year.

Gross margins of 24.3% and adjusted operating margin of 11.9% were slightly lower than last year, as we had more than usual headwind to overcome; many planned, some not. A couple of critical equipment outages caused increased maintenance overtime and freight costs in the period. On the planned side, startup, training and aerospace qualification processes are underway at a number of locations, including at our new carbon fiber precursor line in Alabama, at our new prepreg facility in Stade, Germany, our new carbon fiber line in Salt Lake City Utah, as well as an extensive requalification for prepreg towers transferred from our now closed Livermore California plant.

We have also begun an extensive training program in Salt Lake for newly hired Spanish employees who will be assigned to our new carbon fiber plant near Madrid next year. As outlined last quarter we have also had a major certification and testing program underway for the 787 components made from our new HexMC systems in our engineered products segment. These startup and qualification costs are necessary investments to support the rate of growth to come. And I'm pleased that we managed to cover them and still achieve our target margins.

Let me turn the call back over to Wayne for some additional details, and then we will be happy to take your questions.

First let me discuss discontinued operations. It was a year ago when we announced our program to sell off portions of our reinforcement's business segment. While we are satisfied with the final results, the path to get to here has taken longer than we would have liked. But we will now be entirely focused on the many opportunities [for invest] composite materials, and hopefully you will find our results going forward much more transparent.

As a reminder, the total gross cash proceeds from the three sales will be about $110 million before any possible or announced, and the total expected after-tax gain is about $14 million.

The final one of the three sales is the sale of EBGI to JPS Industries for $62.5 million, which we announced in June. As a result, the EBGI business is now considered to be assets held for sale and are reported as discontinued operations. We have reclassified the prior year's financial statements to reflect EBGI's discontinued operations.

As part of the deal there's the potential for Hexcel to receive up to $12.5 million of additional payments dependent upon future sales of the ballistics productline over the next three years. Those additional payments will be reported as income from discontinued operations when earned. And the earnout is calculated annually based on ballistics sales over $70 million.

We expect the sale to close in the third quarter of this year and to report a $2 million to $3 million after-tax loss when the transaction is closed. The proceeds from the sale will be used to reduce our debt.

Sales of the EBGI business were $45.7 million for the second quarter, or 28% higher than the second quarter of 2006. And the growth was given by a 60% increase in ballistics sales. The business also had a solid operating performance in the second quarter and operating profit, excluding transaction-related costs, was $4.4 million for the quarter. And the business continues to generate positive cash flow.

Also during the quarter we established an after-tax reserve of $9.7 million in connection with the anticipated settlement of claims relating to the previously disclosed U.S. Department of Justice investigation relating to allegedly defective Zylon fiber used in civilian ballistic vests purchased under U.S. government funded programs.

While Hexcel believes it is innocent in this matter, we determined that the cost, distraction and uncertainty as to continuing to defend this matter made the proposed settlement painful, but acceptable. The charge is included in the loss from discontinued operations as it relates to the EBGI business.

Our pretax income from continuing operations for the quarter was $28 million, just above second quarter of 2006 of $27.8 million. However, our 2007 tax provision was $1 million higher than in 2006. So our year-to-date effective tax rate was 42.3% as compared to 39.4% for the first half of 2006. The increase in the rate was primarily due to tax reserves for exposures which have been accounted for in accordance with FIN 48. We expect FIN 48 to increase volatility of effective rate.

A successful outcome of some European audits could return the rate to the 38 to 40% we originally gave guidance for by the end of the year, but it is difficult to predict both the timing and outcome of such matters.

Year-to-date cash taxes were only $9.1 million compared to our provision of $21.9 million. And we continue to expect cash taxes to be lower than the tax provision in 2007 as we continue to benefit from our U.S. deferred tax assets.

Our net debt decreased by $20.2 million in the quarter to $367.9 million. The decrease was both from cash generated by the continuing operations, as well as by the discontinued operations. Year-to-date net debt has decreased $18.7 million, which reflects $25 million from the first quarter asset sales, $6.3 million of cash from our discontinued business. And the ongoing business used about $13 million of cash in the first half of the year, primarily due to normal working capital seasonality. We continue to expect that the net cash flow from operations will fund the Company's capital expenditures for the year, and that our net debt for the year will be unchanged, except for the pay down from asset proceeds.

Inventories as of June 30, 2007 were flat on a constant currency basis compared to March 31, 2007. However, inventories grew by $14 million in constant currency compared to December 31, driven by a number of factors including building and tooling to mould finished parts using the new HexMC materials and processes for the 787, timing of deliveries, increases in aircraft production and normal seasonality.

Capital spending for the quarter was $30.5 million, and year-to-date is now $46.1 million, compared to last year's first half total of $50.4 million. Our largest project outstanding is the construction of the Spanish carbon fiber line, which remains on schedule with the start of production expected in the first quarter of 2008.

With the reclassification of EBGI to discontinued operations we have updated our prior guidance for the year. We now expect we will be in the upper range of our initial guidance of 5 to 10% projected total sales growth for the year. This was due to the stronger than expected commercial aerospace sales, offset by lower than expected growth in recreation and other industrial sales.

We continue to expect gross margins to be in the 23 to 24% range for the year, and adjusted operating margins to be between 11 and 12%.

Now this concludes our prepared remarks, and we would be happy to take your questions.

(OPERATOR INSTRUCTIONS). Steve Binder, Bear Stearns.

Dave, can you maybe just touch on the decline in industrial? It was relatively flat sales, ex wind energy as far as the decline in recreation and transportation. How much of that was quantified supply constraints you touched on with respect to the strong demand out of aerospace versus end market issues?

It was no one overwhelming item. That was a pretty balanced collection of an exceptionally strong second quarter last year, the very serious winter recreational problem. Our recreation -- recreational products in Europe are principally ski-related, and they had a terrible winter. In the U.S. supply constraints or our capacity constraints as we tried to catch this sudden surge in all of the U.S. aerospace demand caused us to divert some resources.

And then there were, as we mentioned, some minor portfolio adjustments that we are looking through to really focus our industrial on those that have good margins and sustainable competitive advantage for the longer-term, like we talked about last fall targeting more on the products that really require high-tech solutions like wind energy does.

If you look at Airbus, I think if you back out the A380 decline, it looks like Airbus sales were relatively flat. You still have build rates, A330s building up, and so is the A320, why do you think sales were relatively flat there?

We're encouraged by the order book on the A330, because that is an important plane to us. The A320 is probably one of our lesser volume airplanes. But I think we also see some impact of the Power 8 squeeze on inventories trying to take some inventory out of the supply chain. That has been an initiative that Airbus has been actively working this year. So I see it a little more as a lag than a flatness.

Lastly, can you just touch on the investment in China that you touched on in the release? Can you spell it out an as far as what you're doing there?

We have two -- our too big wind energy customers both have now started blade manufacturing plants in China. And the shipping of heavy glass prepregs from Europe to China is not very practical. So we have received Board authorization to put a local prepreg plant in China to support those customers. We haven't launched the official agreements with the communities yet, but we are planning on installing some capacity next year.

Steve Levenson, Stifel Nicolaus.

Just to continue on the China idea and the satellite plants, can you tell us what other plans you might have, and what is going on with the satellite plants going forward?

Well satellite plants for those who aren't as informed as you are -- it is a new concept for design that we put forth a couple of years ago that has a large, efficient central mix facility that ships film, resin film to locations that then can have a prepreg plant bringing carbon fiber in independently and manufacture locally, without all the requirements of mixing resins. This concept allows us to improve our quality and save shipping and time in freezers and other costs.

The first application actually was in one of our own plants, but we now have a satellite plant near important customers in northern Germany. And we also have one under construction in the neighborhood of an important customer in Nantes, France.

Is that the same customer?

We will serve all customers in the area, but there is a similar customer that is in both Germany and France actually.

In terms of A350, you certainly mentioned it. I don't imagine you have received any orders yet, but could you give us what you think the timetable is going to be, when they're going to have to tell you what they might want so you can adjust your capacity accordingly?

As we mentioned, I think, in the first quarter we do expect sales to the A350 development and trials this year. And so we have actually received an order and we are -- orders -- and we are shipping. That is not to say we are finally qualified and selected and declared and under contract. But we do and will have -- continue to have sales of materials for A350 development.

As we said, I think on the last call, we would expect that the formalization of decisions on primary prepreg, which is presumably what you're talking about, would likely take place we said in the next 12 months or so. I would think that we would have something clarified by the end of the year. But as you probably notice, there is quite a bit of organizational disruption in the Airbus organization, so we don't have anything specific to report today.

(OPERATOR INSTRUCTIONS). Al Kaschalk, Wedbush Morgan.

Dave, could you just clarify, I want to make sure the investment in China is going to be -- you are going to own plant, is that correct? It is not going to be --?

That is the current plan, yes. I am sorry. We will be probably leasing a building, but it will be a wholly-owned plant. It is not a joint venture. Is that the question?

Yes, I just wanted to make sure that you're either going to own the product that is coming out of there and then selling it, as opposed to having to share in some fashion.

Correct, right.

And then clarification on the focus in on other areas on the industrial side. If I hear you correctly and translate it into English, I think what you're saying is you may be backing away from some of the end market opportunities within there?

Let me try again in English. Tell me if it doesn't come across. The reinforcements portfolio review was really to sort of move away from things that were pure weaving that weren't a part of an advanced composite material or structure material for composites. In the broad sense things like electronics and ballistics were in those categories. But there were also lots of -- not lots -- lots of customers, small dollars in a wide range of distribution markets and other such end markets. As we did the portfolio review the big blocks that we have talked about on these calls have now been positioned for sale or sold. But there are still some residual cleanup where we are trying to zero in on things that we think are better focused and have the long-term potential.

Historically you have talked about incremental gross margins in the 20s and 30%. If I did my math on the adjusted numbers correctly, it is in the high teens. How do you balance that the guidance going forward here for the full year of 23 to 24%, and operating margins I think you said 11 to 12%, with where you stand today, which I think are 24.8% and around 11.2% for the full year? Is the back half presenting some difficulties other than the traditional seasonal weakness in Q3 or --?

Let me say -- that is sort of two questions, I think. The first is I do pay very close attention to incremental leverage, though if the sales are only up very modestly, it is -- it can be kind of a funny number. So I don't worry particularly about the math on that increment this particular quarter.

I do look to see that we get inside the guidance certainly in the first half. I was pretty concerned about the first half and how bad things might be with Airbus. Fortunately, we had some good strength in U.S. aerospace that helped prop us up. We ended up with quite a bit of imbalance though with this huge surge in the U.S. and this huge drop in Europe, not something that we would try to realign for over the short term. So I am actually pretty pleased with how we handle the first half.

Now our guidance for the year, both on gross and operating margin, looks maybe easy when you look at the year to date, but in fact every year that I have been here, and I think five years before that, the gross margins in the second half are lower than the first half. Because, as you said, seasonality with European holidays in particular, but holidays in general in the fourth quarter.

So we've got some work to do to be able to hit our guidance, which we're sticking with. If I were just to take the drop in gross margin that happened last year, second half versus first half, we would be down on the middle part of the gross margin range. I would like to be at the high end of the gross margin range. And we would actually be under the operating margin range, if you did the similar math. And again, I do want to be in that range. I would like to be in the middle of that range.

We have got to get what operational issues we left on the table in the second quarter fixed. We have got to maximize the opportunity on the sales growth, which I do expect to be stronger in the second half, to hit those numbers.

Then finally on the R&T expense down from the first quarter, but it looks like you're trending above last year's number and closer to about 9 a quarter. Is that -- are you concerned at all about that getting away from you, meaning hitting a little bit above trend, despite the positive outlook that you have for qualification on newly airframes?

As we have said before, we have a base level of R&T that has to do with staffing and programs that we monitor very closely, and that doesn't move around a lot. Now that we've got qualification cost captured in this line, you're going to get some bouncing around. And I'm not too worried about it, because it all is -- that increment is all directly related to future sales. So I am not too worried about that. It is more a matter of keeping up and getting the qualifications done in a timely manner than it is a drift in expenses that has gone unchecked.

(OPERATOR INSTRUCTIONS). There appears to be no more questions, gentlemen.

Okay, thank you very much everyone. Talk to you next quarter.

This does conclude today's conferences. You may disconnect your lines at this time.