Hexcel Corp (HXL) 2007 Q3 法說會逐字稿

Good day, everyone, and welcome to the Hexcel Corporation third 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, sir.

Great. Thank you. Good morning, everyone. Welcome to Hexcel Corporation's 2007 third quarter conference call on October 23, 2007. Before beginning, let me cover the formalities. First, I want to 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 express permission. Your participation on this call constitutes your consent to that request.

With me today are Dave Berges, Hexcel's Chairman and CEO, and Michael Bacal, our Communications and Investor Relations manager. The purpose of the call is to review our third quarter results detailed in our press release issued last night. First, Dave will cover the highlights and then I'll cover some of the financial details, and then take your questions. So let me hand call over to Dave.

Thanks, Wayne. On the top line, the third quarter showed solid revenue growth, with commercial aerospace again leading the way with double digit gains. Sales of $281.1 million were up 11.4% on an as-reported basis or 8.4% from last year when you factor in changes in currency.

Summer shutdowns, particularly in Europe, have always put seasonal pressure on margins but productivity initiatives, cost control and mix combined to provide our best third quarter margins in history. Gross margins for the quarter increased to almost $67 million to 23.8% of sales; 110 basis points higher than our performance in the comparable quarter last year. Operating income of $30.2 million included $2.6 million of restructuring costs. Excluding these costs, margins were 11.7% of sales; 200 basis points higher than last year.

We had good leverage on the $29 million incremental sales growth. Gross margin on the incremental sales was in excess of 33% and incremental adjusted operating margin was over 29%. While the third quarter of 2006 admittedly offers an easy comparison, we are also covering a number of unusual expansion and development activities this year. We have underway extensive efforts to train new operators and qualify a number of major equipment installations, including new fiber equipment in Alabama, Utah and Spain, and prepreg lines in Utah, Austria, Germany, France and China. Each of these projects will fuel our profitable growth for years to come and I'm particularly pleased that we are regaining our margin expansion traction despite these incremental costs.

Our diluted EPS from continuing operations was $0.19 for the quarter as compared to $0.16 for the comparable period last year despite a 7.5 point higher tax rate. For a more detailed understanding of revenue trends, I'll cover the growth rates in constant currency dollars since the dollar is almost 8% weaker than the European currencies as compared to last year. It's important to note that while the weak dollar results in some of our sales translating into larger dollar amounts, it does not help our bottom-line, as we have a fair amount of dollars sales matched with euro and pound costs. We do hedge our exposure in layers, so some of the pain has been avoided, but if the dollar continues to weaken, it will be a headwind to earnings next year and beyond.

Commercial aerospace sales were $152.8 million for the quarter, up 13.7% in constant dollars from last year. Sales to Boeing and subcontractors, engine and [the cell] makers as well as regional and business aircraft OEMs were up over 25% in aggregate in the third quarter in a row. We do not expect the recent announced delay of delivery of the first 787 to significantly impact us, as Boeing's current plan to ship 109 aircraft by the end of 2009 requires a significant ramp up throughout 2008 at the raw material level.

Airbus revenues were down less than 5% for the quarter, as the year-on-year impact of the A380 push out wanes and comparisons become easier. It's been a difficult year for all suppliers heavily involved in this program, but the news of late is encouraging. On October 15, the first A380 was delivered to Singapore Airlines and makes its maiden revenue flight Thursday from Singapore to Sydney, Australia. During the past 12 months, five airlines have increased their A380 orders and two new ones have placed their initial orders; most notably, British Airways, who operate the world's largest 747-400 fleet. So now all three top European major airlines have committed to the A380.

As we've said in the past, forecasting the early stages of production restart for the A380 is difficult, but we are now starting to see demand for our materials pick up and we expect to see sales growth for the program beginning in the fourth quarter.

The commercial aerospace market including regional and business jets is performing well, and industry analysts are optimistic that it will continue to grow in the years ahead. Boeing and Airbus combined have now reported over 1,800 orders this year. Their combined backlog stands at over 6,000 aircraft; over six years worth at current production rates. Rising fuel costs, while not good for the economy in general, make the economics of lighter aircraft more compelling. Weight reduction targets for the 787, the 747-8, the A350 XWB, and the aircraft beyond have increased the intensity and intimacy of our customer relationships as we strive to provide new solutions. And while it has increased our technical support workload, we love the longer-term implications.

Overall, reported sales for our industrial markets of $67.9 million represented 24% of our sales for the quarter and were down 4% on a constant currency basis. Wind energy sales were very strong as they were last quarter. Our customers are now prepreg-based blade factories in Spain, the U.S. and China that should provide continued opportunity for growth.

We have recently commissioned additional glass prepreg capacity in Austria, are qualifying an additional line in the U.S., and are now beginning construction of a new Chinese plant to support this increasing demand. Sales for recreation and other industrial applications were again lower than last year's period with weak sales of winter sports products in Europe a key factor. Other industrial sales in the U.S. declined as well for the quarter as we continued to devote resources to the rapid aerospace growth.

We've also narrowed our focus related to a number of woven product customers and applications that remained after the sale of the EBGI business. We don't expect further significant reductions in these submarkets on a sequential basis, although it will be a couple of additional quarters before the year-over-year comparisons stabilize.

Sales to space and defense markets were up 11.6% in constant currency, bringing the year-to-date growth to 9.5%. Strong global demand in rotor aircraft and U.S. military aircraft were the main drivers for growth this quarter. The overall outlook for helicopters remains very robust and the major air framers are all reporting strong backlogs. Increased work loads have also led to more outsourcing by some customers and Hexcel's engineered products business have long been a leader in composite blade sub-assembly work.

On the capital spending front, we recently announced our next carbon fiber capacity expansion program; a 70% increase over the next three years. This expansion is needed to meet existing customer forecasts for programs such as the 787, the V-22 Osprey, the F-35 joint strike fighter, and the recently announced contracts for uranium enrichment rotor tubes for the American centrifuge plant. These are big investments but have big rewards. Our confidence is bolstered by the outstanding performance of our facilities teams on recent capital projects.

Now let me turn the call back to Wayne for some additional details.

Thanks, Dave. First let me discuss discontinued operations. We did complete our portfolio realignment this quarter with the final piece being the sale of the U.S. electronics ballistics and general industrial reinforcement product lines. The gross cash proceeds of the sale were $62.5 million plus up to $12.5 million of additional earnout payments based on the futures sales of the ballistics product line.

The after-tax loss in the sale of our discontinued operations was $2.4 million but we also had the benefit of the earnings for the EBGI business through early August, so the net loss for discontinued operations resulted in about $0.01 per share.

The operating margin for our Composite Materials segment was 14.6% for the quarter compared to 14% last year. If you exclude restructuring expenses, then it was 15.5% for this quarter compared to 14.2 last year; a 130 basis points improvement. The engineered products operating margin for the quarter was 8.6% compared to 9.8% last year, but almost even at 9.7% without restructuring despite the higher R&T and startup costs related to the 787 components made from our new HexMC system.

Our pretax income from continuing operations for the quarter was $24.4 million, which is 34% higher than the third quarter of 2006 of $18.2 million. Our tax rate for the quarter was 29.5%, substantially lower than the first half tax rate of 42.3%, but well above the 22% effective rate in the third quarter of last year. The sequential drop in the rate primarily reflects a favorable agreement with UK tax authorities, which allowed the release of $1.1 million of FIN 48 reserves and allowed for a one point run rate improvement going forward.

The third quarter of 2006 was pre-FIN 48 treatment and had the benefit of a one-time $3.6 million valuation allowance reversal. We now expect our rate for the full year to be approximately 39%. Year-to-date cash taxes were only $14 million compared to our provision of $29 million as we continue to benefit from our U.S. deferred tax assets.

Our net debt decreased by $75 million in the quarter to $293 million. The year-to-date net debt has decreased $93 million, which reflects $84 million from asset sales, $6 million from our discontinued operations, with the ongoing business generating a small amount of cash in the first three quarters of the year as we have funded almost $72 million of capital expenditures so far this year and $11 million of cash restructuring. The $15 million liability recorded in the second quarter for the settlement of the Zylon matter is expected to be paid in the fourth quarter.

Our working capital increased less than $5 million this quarter; well in line with our sales prospects going forward. Our base inventory requirements have increased in the last year for certain strategic investments such as tooling for new HexMC parts, carbon fiber and startup of the new satellite plants. After adjusting for the strategic increases, our days on hand on a looking forward basis are similar to a year ago.

Capital spending for the quarter was $25.3 million and, as just mentioned, year-to-date is now almost $72 million as compared to the $82 million for the first nine months of 2006. We expect a high level of spending in the fourth quarter, particularly related to our carbon fiber expansion programs and still expect full year capital expenditures to be in the range of 2006 levels, which were almost $118 million.

Restructuring and business consolidation expenses for the quarter were $2.6 million as compared to $500,000 in Q3 of 2006. Expenses were driven by the costs associated with preparing the Livermore, California plant site for sale and severance costs associated with the Company's previously announced plan to reduce [stranded] costs following our portfolio realignment.

Now let me turn it back to Dave for some final comments.

Thanks, Wayne. All of these comparisons to last year are restated for continuing operations. But as last year's third quarter was the last full quarter with EBGI and the other weaving operations we divested, it's worth one last look back at our portfolio realignment decision.

If you look back at last year's press release, you'd see Hexcel pre-divestitures. You'll see that we had $289 million of sales and $27 million of adjusted operating income. This year, despite divesting $37 million of those sales, our adjusted EBIT is up almost $6 million. At $281 million of sales this quarter, we've almost covered our lost sales with organic growth already, and year-to-date gross margins are 200 basis points better. More importantly, our high versus low growth revenue profile has gone from 75/25 high growth to 90/10, with the most dramatic part of the composite penetration story still ahead of us.

It's been a painful year of realignment, but we sure like where we are now. We appreciate your patience through these months. And we'd be glad to take your questions now.

(OPERATOR INSTRUCTIONS). Steve Levenson, Stifel Nicolaus.

Good morning, David, Wayne and Mike. Can you tell us how you plan to finance the next phase, the expansion, please? Is that something you'll do from operating cash flow and bank debt or will you need to come back to the markets for money?

We'd like to cover it from operations as we were able to last year. And we'll be close to being able to this year, the way it's spread out and the way we expect our cash flows to grow. We expect to -- pretty close to be able to cover it. If not, our current revolver certainly is plenty for it; don't expect to be back to the market.

Thank you. Second item is there's recently an announcement that the joint venture in China has been approved -- transfer some technology. Can you let us know what the significance is of that procedure?

Nothing in particular. It's just very difficult with dealing with China with certain technologies, particularly in aerospace. So, it's just a procedural matter that makes life a little easier for Boeing and Hexcel in China.

And how is that joint venture going now? Is it contributing profits or still sort of breakeven?

Both joint ventures are at a nice size and contributing nice profits. So you'll see those on our equity and earnings line. Those are the only two items in the equity and earnings line, right, Wayne?

Right. Correct.

Okay, last item, in terms of our getting the HexMC qualified for 787, does that relate to the window frames that are already out there or is that something new?

No, the window frames have been certified for some time. The components that we're manufacturing in our engineered products business are getting qualified on a part by part basis. So, any time we get a part that is identified to convert from metal to HexMC, we have a big procedure to go through to get that individual part or family of parts certified. So we've been going through that process for the last year. Each one requires engineering resources; require tooling that would later be amortized through price and require individual qualification certification. So the more parts we win, the more of that we have and the more sales we have going forward.

So does that mean it's now more than $1 million to $1.3 million for 787? Or is that included in that original number?

That's included in the original number, though any delay or opportunity for inserting additional weight reduction components provides additional opportunity going forward.

Okay, great. Thanks very much.

Steve Binder, Bear, Stearns.

Good quarter. Dave, can you maybe quantify when you look at the inefficiency costs from the plant ramp ups and the exit from Livermore and so forth, can you possibly quantify how big a nugget that might have been in the quarter?

Well, I think we gave you sort of a general idea of the second quarter. And I would say the third quarter is better than that. So, we're improving and we're obviously generating good incremental margins on it. So, any business that has this kind of complexity, especially in a ramp up, has difficulties. But all in all I think it was a pretty good quarter and I think we'll get better still in the fourth quarter.

So you think the fourth quarter will see similar kind of year-over-year incremental margin performance?

Well, I'd have to look at what the fourth quarter was. It's obvious that the third quarter last year was an easy comparison. I do expect -- or certainly target the kind of incremental leverage that we delivered for all the years before we had the growth stall last year.

And then with respect to headcount, can you maybe address where headcount is today? How it compares to the beginning of the year and what does it look like at the end of the year?

We don't provide those numbers but I will tell you that I look -- or you've seen those charts that I provide that show our LTM sales and then our overall headcount. It's sort of a simple indicator of productivity. And we've increased our sales per employee, I think, every quarter since September of 2001; this year being no exception. Our headcount, with the divestiture of those reinforcements businesses is obviously down. But I believe our sales per employee is still up sequentially.

All right. Thank you.

John McNulty, Credit Suisse.

Just a few questions. On the recreational portion of your industrial business, can you quantify exactly how big that part of the division is? I know it's shrinking, but just try to put some parameters around the size of it.

Well, we don't break that out, John. I'll tell you, though, that it is not the second biggest. Unfortunately, I have to tell you the second biggest after wind is other. We have such a wide range of distributors and a wide range of applications. We track internally; we track recreation, automotive, wind, and other industrial. Other industrial is the next biggest. So recreation isn't huge. It is down.

The reason, though, our non-wind industrial is down is as much due to applying our current capacity to the rapid growth that we've got in the U.S. in aerospace and some purging of business customer's applications that weren't as attractive that are part of the old weaving operations not included in the divestitures. So, it will take a little while to stabilize but then I would think that we'll have a new base level and the non-wind sections of industrial will be a little more steady. And then we'll get to layer on that in our other category, the rotor tubes for the American centrifuge project. As that project gets going, you'll see growth in every single subsegment.

Okay, great. Now, that's definitely helpful. On a different topic, you had highlighted a lot of strength in the rotor craft area. I'm just curious what kind of visibility you have in to your customers' inventories? We had heard at least from one of your competitors that there might be an inventory issue there, but you guys don't seem to be feeling that at all. And I'm just trying to reconcile that.

Well, I would say that the whole military -- the whole space and defense segment has always been lumpy for us. And the only explanation I can offer you is that people tend to build in tranches or waves or campaigns. And you end up with some funny bouncing around.

I did hear that one of our competitors talked about an inventory correction. I've not seen it. But we have different approvals and different programs at different customers. So it doesn't surprise me at all. And I wouldn't characterize it -- not to speak for my competitor, but I wouldn't characterize it as a problem in the rotor craft industry. It's going very strong, very well.

Our visibility into our inventories is reasonable because our materials have to go in freezers. Usually when we're talking about inventory in this market it's that they've built up a number of wings or a number of bodies or a number of blades, more than what they need for their assembly. So it's more their inventory than ours.

Okay, great. Thanks very much.

(OPERATOR INSTRUCTIONS). Al Kaschalk, Wedbush Morgan.

I was hoping you could give us a little bit more color on the ramp in the 380 sales that you expect in Q4. I know it should be small, but particularly any visibility on the 380 production ramp would be great. Have you heard specifically from Airbus in terms of your next 12 months or when do you expect additional color from them?

Well, what I said in my prepared remarks is about as specific as I can get because it's really hard to track. I did not say that the growth in the fourth quarter will be small, nor did I say it would be large. You said that; I did not. The way we try to track this is, again, there are like 30 locations or customers, sub-tiers or Airbus locations that we deliver to. And each one sort of has a production plan that they now are starting to share with us for next year.

Some of them are up significantly. Some are up modestly. A couple of the 30 are flat or down. So, in general, we feel good about all of the production plans. Some of them are up enough that we're starting to be pressed for deliveries in the fourth quarter. We, of course, have to ramp up to be able to get to those rates. But we think that the A380 is going to start to be a year-over-year contributor yet this quarter.

Okay. Would it be fair to say then we should be thinking that the Q3 margin, particularly on the gross side which is generally one of your -- pardon the expression -- softer quarters at that level, that this could be a trend going forward if you do, in fact, expect the net production volumes to increase? Because you're certainly focusing on incremental gross margins that looked very positive in the quarter.

Yes. You know, I always expect good incremental gross in operating income leverage. And when we had volume in the last five years we've always delivered it, I believe. The slowdown in sales this year or last year with the ballistics decline took away that tool that we have. But now it's coming again. So I would expect to see good incremental margins going forward as we had in the past when we had volume leverage.

Let me take one other stab at it. Was the margin you posted in the quarter better or in line with your expectations for Q3?

My expectations -- I was pretty pleased with it. I worried -- I think I talked about that on the second quarter call -- because of all the holidays and shutdowns, we have a history of a sequential drop of about 2% when you go from second to third quarter. And we didn't have that this year. I feel real good about that. I'd say it was at least as good as what I expected.

Fourth quarter also tends to be a little tougher than the first half for the same reasons; holidays and what goes on at the year end with customers. Though it's more volatile, there are a couple of years when our customers were actually pulling inventory in at the end of the year. Other times they try to push it out so they can manage their year-end inventory. So it's a little hard to predict. But we've maintained our guidance, so I'm saying I'm hoping that we're still going to have decent margins in the fourth quarter despite all the holiday kinds of problems.

On the wind business, you've traditionally said it's very poor visibility or limited visibility in the next couple of months. Can you talk about what you're seeing there in terms of either your production outlook for the next couple of quarters or even a little bit longer term than that?

Well, first I'll say that we don't have anywhere as near as good a visibility and we often get surprised in this market. That said, I feel a little bit better today than I did six months ago. If you look at some of the Vestas press releases, they point to sort of a lull or a slowing of their build rates in the first half as they tried to get their whole supply chain better aligned and in sync. And now it's getting going again.

We've seen the same thing in our sales. Our year-over-year sales growth was higher in the third quarter as you're comparing year-over-year than the second. And both were well higher than the first quarter. So, it seems to me that the supply chain of hardware still struggles, but it's less prominent in press releases from our customers or in trade magazines. So I sense that they're starting to get a little better organized and start the growth better. In the increase of capacity, of blade making capacity, is what we really need to be able to take it to the next level. And both Gamesa and Vestas, our biggest customers, are increasing blade capacity, as are we. So, I feel better about it today than I did six months or a year ago.

Karl Oehlschlaeger, Banc of America Securities.

Can you talk a little bit about some -- maybe kind of give an update on where things stand with the A350 and that whole process?

Well, the A350 qualification -- or actually, it's a selection process -- is what's underway. So, Airbus is trying to decide exactly what material, what specification they want to define for the next airplane. They know they're going to be at it for a long time. They've got some time to work with it so they've been working with a number of variations; from an existing material to some newer technology materials, to variance in between.

The progress has been slow. We are encouraged by our prospects but don't have much more to say about that other than we still believe a decision on the primary prepreg will be made in the next three to six months. I think there will be lots and lots and lots of opportunities for all kinds of other materials, just as there still are in the 787, for years to come. But the primary prepreg is the thing that we're focused on right now and I'm sure that's what you're referring to.

Yes. Okay, thanks. And then just on the restructuring expenses, how should we think about that going forward?

Yes, Karl. I mean, the guidance we originally gave was $5 million to $7 million. We're a little over $4 million year-to-date. And we probably still expect to be in the middle of the guidance for the year. And then hopefully in 2008, it will taper off.

Okay. And just finally, I guess on tax -- I think your guidance now is implying about 41% in fourth quarter, if I got it right. How should we be thinking about that number going forward, as well?

Yes. I mean, tax one is tough. For 2007 our expectations are 39% for the year, which gives you what you just suggested for the quarter. We'll give guidance for 2008 later in the -- near the end of the year and we'll probably have a better handle on it. But there's a number of things we can do to reduce the tax rate and we're trying to do that. We'll have to see how those develop before we give guidance for next year.

Okay. Thanks, guys.

Peter Grondin, OSS Capital.

Nice quarter. More strategically, the expenditures you announced two weeks back for the next step in carbon fiber capacity, is that capacity going to be used mostly for existing business or new business? I know you talked a little bit about what you -- in terms of some of the new opportunities -- but is some of that capacity going to be used for stuff that's on the drawing board? Or is it mostly stuff that's sort of in the pipeline?

As we said in the release and in the comments, we need that capacity for existing platforms with the projected growth that they have plus the American centrifuge project, which we just announced this summer. So the only one that's really new in there is the uranium enrichment tubes; but that's just a part of it. So things like the joint strike fighter -- we're sole source carbon fiber on that. And while that's been a long, slow process, as the build rates ramp, in two, three, four years, it requires a lot of carbon fiber.

787 -- things like the GE90 fan blade and the GEnx fan blade and the composites that are used [in them to sell], those all add up to quite a bit of capacity requirements going forward. So our current build, what we're currently installing plus what we identified in there is required even without the A350 or any new airplane.

Okay. So to the extent you can discuss it, theoretically more build needed for -- were you to get a win on the A350 and potentially more build needed if you were to branch off into some of the things you talked about at last year's Analyst Day, and the oil and gas face and that sort of thing. Is that a fair assumption on my part?

Correct. But in the case of the A350 or the next generation 737 or A320, recognize it would be out a ways. So we sort of envision that, as we've said before, if we're successful, you'll see last year's kind of CapEx rate being sort of the norm. So we think we can lay it down in tranches. We've got a pretty good set of engineers who have done a good job in Salt Lake are now putting down the next one in Madrid. We put the next one down in Salt Lake. And we think this will be a pretty steady spend rate for years to come if we're successful on these new aircraft.

Nigel Coe, Deutsche Bank.

So, you mentioned, Dave, the Airbus looking at a wide range of materials, from what they've got now to some radical designs and somewhere in between. Can you just give a sense on where Hexcel has positioned itself in regard to that range?

Hexcel has got the broadest range of prepregs in the business, in my view. And we have a long history of working with Airbus and I like our position.

You sound pretty confident. Then looking at margins going from 3Q to 4Q, you made a reference of 3Q is generally seasonally the weakest quarter for the margins. Will you expect the EBITDA margins to step up from 3Q to 4Q similar to what we've seen in the past?

Actually, I haven't looked at that preparing for the call; I look more at history. Wayne, do you want to take a swing at that?

Sure. Nigel, the fourth quarter, if you look at our -- by quarters, the first half has always been much stronger for us than the third and the fourth quarter. And Dave gave the reasons why the third quarter and the fourth quarter both have just -- tend to be lower than the first half. And if you look at last year, the fourth quarter of last year looked unfortunately a lot like the third quarter.

So, we would hope we'd go into the fourth quarter and have a similar fourth quarter this year as we did the third quarter this year. So, when you go to compare it to last year, it will hopefully look better.

Okay, okay. Great. That's fair enough. And just finally, you made some reference to the startup costs for the new facilities. I read that as maybe increasing pressure on margins in 2008. Is that the right way to think about it? Or did I misread that?

No, no. I don't think so. I would say hopefully the second quarter was where that was the toughest. It's where all of those things really started. But as we started those, some of those lines are also putting out salable product that's contributing margin above the startup costs. So, we had those startup costs yet again this quarter and I'm sure we will the next couple of quarters. But we also have more output coming out of those new facilities. So, I would say that we're gaining ground, not losing ground.

Okay. Thank you very much.

And at this time, we have no further questions in the queue. Ladies and gentlemen, that does conclude today's presentation. We thank you for your participation. You may now disconnect.