Hexcel Corp (HXL) 2010 Q2 法說會逐字稿

Good day, everyone, and welcome to this Hexcel Corporation's second-quarter 2010 earnings release conference call. As a reminder, today's conference is being recorded.

For opening remarks and introductions, I would like to 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 2010 second-quarter earnings conference call on July 27 of 2010. 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 2009 10-K, our second-quarter 10-Q, and last night's press release.

Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be recorded or pre-broadcast 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 2010 second-quarter results detailed in our press release issued yesterday. First, Dave will cover the markets, then I will cover some of the financial details before taking your questions.

Thanks, Wayne. Second-quarter revenues of $305 million were up 10% from 2009, or 12% higher if you adjust to a constant currency comparison, and 18% higher than the first quarter on an FX-adjusted basis.

Operating income of $40.5 million or 13.3% of sales was substantially higher than last year's adjusted $31.4 million. The operating income of $40.5 million is the highest in our history, yet on sales, 15% below our second-quarter 2008 sales peak. Our diluted earnings per share of $0.23 is $0.05 above the adjusted EPS of $0.18 in the second quarter of last year. We're particularly pleased with our second straight quarter of over 25% gross margins.

Now let me cover the markets using constant dollars to describe the sales trends.

Commercial aerospace sales were $161 million for the quarter, up 18% in constant currency from last year's second quarter and 6% higher than the first quarter. Airbus and Boeing-related sales were up about 20% from a year ago and were the highest level since the peak of 2008.

Sales growth was driven primarily by new Airbus and Boeing programs, that is, the A380, 787, 747-8, and the A350. New program sales, in fact, doubled for the quarter as compared to last year and now account for more than 20% of our commercial aerospace sales in the quarter. Sales to other commercial aerospace, which includes regional and business aircraft, were slightly higher than both last year's quarter and 2010's first-quarter's levels, seem to have stabilized at about $100 million per year rate.

Sales to space and defense markets were up over 7% on a constant currency basis versus the second quarter of 2009 and 9.5% sequentially, as growth in composites for rotorcraft outpaced the wind-down of the F-22 program.

In industrial markets, sales were $64.7 million, up almost 4% in constant currency versus last year, and up 68% compared to the first quarter of this year. After the significant inventory correction by our largest wind turbine customer in the first quarter, our wind energy sales were up more than $20 million sequentially and have now returned to the 2009 second-half run rate as we expected. Recent large orders announced by Vestas give us confidence for the near-term with wind sales, and we remain cautious about the timing of the return to significant growth.

In total, our remaining industrial sales beyond wind were flat compared to a year ago in constant currency, but up sequentially. But with the exception of the decline in the sales to USEC's American Centrifuge Project, which was put on hold after the second quarter of last year, all other industrial submarkets were up sequentially and year-over-year.

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

Thanks, Dave. As Dave pointed out, our adjusted diluted earnings per share was $0.23 compared to $0.18 a year ago and were up 53% from the first quarter of this year. For the first half of the year, we are at $0.38.

Gross margin of about $78 million for the quarter was 25.7% of sales, 290 basis points greater than a year ago. The improvement reflects the higher volume, factory productivity and cost reduction initiatives, and favorable product mix. In addition, exchange rates contributed about 50 basis points in the improvement, enough to offset the $1.5 million step-up in depreciation expense included in cost of sales that is primarily due to the completion in the quarter of our newest carbon fiber precursor line.

Selling, general and administrative expenses for the quarter were $29.6 million or $4.3 million higher than last year's quarter, primarily due to the impact of our improved outlook on variable compensation expenses versus the same time last year. Research and technology costs were $8.3 million, almost $2 million higher than last year, reflecting higher development qualification costs for new commercial aerospace programs. So our operating income for the quarter was $40.5 million or 13.3% of sales as compared to adjusted operating income of $31.4 million or 11.3% a year ago.

Interest expense for the quarter was $7.1 million. As we mentioned in the release, earlier this month, we successfully refinanced our senior credit facilities to a new five-year facility, which lowered our additional interest rate by 125 basis points, and more importantly, removed the 2.5% LIBOR floor from the prior facility. We expect this will lower interest costs over the next 12 months by more than $5 million based on current borrowing levels and forecasted LIBOR rates.

The payback on the $3.7 million of refinancing costs should be about nine months. Remind you that the third quarter will include a charge of $6.8 million for the accelerated amortization of the deferred financing costs of the old facilities. After tax, this is about $0.04 per share.

Our year-to-date effective tax rate was 30.8%, excluding one-time items, which is in line with our expectations. We now have over 90% of our the euro and British pound exposure at the operating income line hedged for the year, so further exchange rate movements will not significantly impact our 2010 operating income dollars. Our average hedge rate for the second half of the year is slightly more favorable than last year's average rate.

Our free cash flow for the first half of the year was about $12 million as compared to last year's $22 million. Our higher sales and improved outlook led to the use of nearly $44 million of cash in the first half of the year from higher working capital, but capital expenditures remained well below last year. We do expect the pace of capital expenditures to increase in the second half of the year but to be less than $75 million for the year.

Now let me turn the call over to the Operator to take your calls.

(Operator Instructions). Noah Poponak, Goldman Sachs.

Your commercial aerospace business, I think, in normal years is stronger in the second half and has tended to have particularly strong fourth quarters. This year, if you'd just model it flat sequentially from the second quarter, you'd still show over 20% year-over-year growth just because the comps are so easy. But I think it would be up sequentially, given we've got higher rates announced and you guys are alluding to progress and new programs. So I guess what I'm getting at is, just how big are the year-over-year growth rates for aerospace going to be in the back half?

Well, the new programs are stronger than I expected this quarter. I hope they're going to continue. A380 does seem to have started to get some traction and we're finally starting to ship again, so I think that's going to keep going. 787 has come on pretty strong and I hope it's not getting ahead of itself with respect to inventory. Of course, we need those programs to come off on time. So I would say new programs probably will still look about as strong, at least in the second half.

You're right, we have some easier comps, particularly the third quarter, which was our bottom-bottom last year, so we think we'll end up with a pretty good looking percentage in the third quarter. I don't think business in Regional Jet is really going anywhere any time soon. And the only thing left is what future ramp-ups due to us at the end of the year or if there was a bit of an inventory correction that still has yet to be played out. But I would think high teens would be an easy average for the second half on commercial aerospace.

Okay. And on that point, the inventory movements related to production rates on the legacy programs, I think you and some others that are longer lead suppliers had talked about being destocked pretty hard when everybody assumed there were production cuts coming. Production cuts didn't come; now we're taking rates higher, but it sounds like many of you are saying you haven't yet actually seen that play out in order flow. Is that right? And when should we start to feel that impact?

Well, I sure don't think it's a precise science. We thought we overshipped by, as I recall, 10% versus line rates in 2008 and undershipped by about 10% in 2009 -- really an inaccurate science. I did look at the seven quarters prior to the Boeing strike and would say we are still running on legacy programs, maybe $5 million a quarter lighter than we should be.

So, the only -- it's so inexact I wouldn't get too carried away with that. I mainly went through the exercise to see whether the second quarter was overhyped, whether people were ramping up too fast and that we were going to have a settling out. My conclusion is second quarter was a good quarter and not over-heated.

Okay. And I'll throw in one more. On the wind business, you're making the comment that you're cautious on the timing of the return to significant growth. I think Vestas received its largest order ever in July. Is that correct? And can you just give us a little bit more color around what you are seeing on the wind side?

Well, it was the largest order in the US. They have had trouble penetrating the US compared to General Electric or getting their share up in the US. So it was the largest in the US, which is very encouraging. They're going to make the blades, they say, in their Windsor, Colorado facility, which is encouraging since we have a prepreg plant for their Windsor blade plant right down the street in Colorado. So we're very happy with that order.

It's a big order, but this is a very short-cycle business or at least it's behaving that way of late. That order, I think, compared to what they wanted to have for total for the year is --

About 10%.

10% of what they said they wanted for orders for this year, just to put it in perspective. So we're thrilled to see that. I think they said half of it was going to ship this year, which points to the fact that their backlog is pretty close, it's pretty tight. It's not like the seven-year backlog Boeing and Airbus have. So it's why we still are a little cautious about it. We need to see more and more orders.

China's still a question mark, whether the government is going to give Western providers turbines a fair shot at participating in their growth. Europe is doing better, particularly with offshore and in the UK. So we're encouraged that wind is going to be stable for awhile. We expect longer-term it's going to be back on a serious ramp-up, but I don't think it -- a rate today, I wouldn't predict that it's going to have the slope that we had in prior years nor would I say when that slope starts. So, as we've said the last two or three calls, I think the safe bet is to say industrial sales in the second half of this year might look a lot like last year.

Okay. Thanks a lot. Good quarter.

John McNulty, Credit Suisse.

This is [Abi Rajeenrin] calling in for John McNulty. I had a quick question about the space and defense business, which came in very solidly with a record quarter. Given the lumpiness of the business, how should we think about it for the second half, especially given the F-22 wind-down?

Well, the F-22 wind-down, I think that the impact seems to me about three quarters work -- we still are shipping F-22 materials, partly spares, to the spares market, I should say, customers who are making spares. It's running about one quarter of what it was before. I think for two quarters now, so we have two more before we lap it -- one more before we lap it, Wayne tells me.

The strength this quarter was, as we said in rotorcraft; in particular, V-22 came in pretty strong, that is a little stronger than we would normally expect, so I would call that part of the lumpiness where you're normally expecting.

I think, generally, we say low single digit kind of growth is what we'd look for. The fact that we have such a strong second quarter, maybe I'd back off on that a little bit, but no big movement either way. I don't expect a big drop-off. I don't expect explosive growth; just single digits probably plus, possibly minus on a quarter or two.

Got it. And just a quick follow-up, if I may. You'd given an update for about 10-plus percent growth going forward at your Investor Day recently. Given the recent data points that have come out of the Farnborough Air Show and further ramp-up data on new planes, any update on that forecast?

Well, we said double-digits, you said 10%-plus. That double-digits covers a lot of ground. So I would say we're still safely in the double-digit range. The growth, as the previous caller went over, is going to be very strong on the Boeing and Airbus portion of commercial aerospace, which is about 40% of the Company. It's enough that it's going to be carrying the rest of it, assuming space and defense gives us single digits.

So I think until we see some significant growth in business and regional jets or wind, all the growth is going to be coming from Boeing and Airbus, but you have to just tamp it down a little bit by recognizing it's 40% of the Company and not 100% of the Company.

Got it. And just one last quick one. Any update on the USEC contract for the Centrifuge Project coming back?

No update other than what you've seen publicly. They're hoping to reapply to the DOE sometime later this summer, I believe, is what I saw last. They are seemingly optimistic, as are we. But we think that if it does get the approval, that it won't result in significant sales for us for probably another 12 months or so because of prior shipments.

Okay, got it. Thanks very much.

Steve Levenson, Stifel Nicolaus.

How much longer do you think the qualification costs are going to run at this level? Or do you think it's going to be sort of up and down (multiple speakers) [the next] --?

I think it's sort of up and down. I don't expect big numbers. It was a little bit more this particular quarter than most, but I don't see -- as a percent of sales, I don't see any big changes in the R&D run rates.

Okay, thanks. One of the things that came up at Farnborough last week was the re-engineering or new aircraft design to replace single-aisle planes. And the CFM guys with the LEAP-X seemed pretty confident, while the Geared Turbofan guys seemed a little defensive. What sort of impact could LEAP-X have on Hexcel, since the [pulled] section fan and fan case were made out of your material?

Well, the current view of the LEAP-X is an infusion fan blade that would be good for us from a carbon fiber perspective, but it wouldn't be prepreg like the GEnx engine or the GE90 engine. All of the engines are likely to have a lot more composites in the cell and containment cases and so forth. So regardless of who the winner is, I'm sure there'd be some significant in the cell and accessory parts to it. The core engine itself, though, the Geared Turbofan is still a metallic fan and the CFAN is presumably going to be carbon fiber.

And this is something that could be $100 million a year run rate for you, more or less?

I don't have a number because I don't know what kind of engine count or re-engining. It's a little early for me to be figuring out. I mean, long-term, if they re-engine or if they put a GEnx engine on a narrowbody, like a 737 or A320, I'm sure it'd be a good-sized number. But I don't see that as a near-term of big swing either way.

Hey, thanks a lot.

Ronald Epstein, Bank Of America Merrill Lynch.

This is actually [Christine Leewa] calling in for Ron. Can you give us more color on your operating margin performance, especially in composites? Were there any one-time items in the quarter or is the 17.1% more of a sustainable rate going forward?

Well, those are two different questions. There aren't any big one-times in there. It's a wide spread improvement; in fact, all the business is a good wide spread across-the-board sort of performance, almost every plant, almost every product. We typically have a seasonal step-down in the second half from the first half, I think, almost every year since 2001, with the exception of one for seasonal reasons. So I would expect it to pull back a little bit.

Just in general, we hope to continue all the improvements we've had. We're in a pretty sweet spot with respect to capacity utilization. If you get up to 100% or 110%, like we were in the second half of -- in the second quarter of 2008, it starts to get difficult. We're coming up off of a low base and are able to put up some pretty good leverage numbers and I hope we can continue that.

I guess a quick follow-up. What's your capacity utilization now? You said you're in a sweet spot, right? So, like, what kind of range are we looking at?

I guess I set myself up for that question. It's -- a single number doesn't really make a lot of sense with our business. We've got multiple products; many products are only qualified on certain lines, so there's a wide, wide range of where we are capacity-wise. If I had to come up with a real general number, I would say that in the second quarter of 2008, when we were running 15% higher than this, we were just about out of capacity and just about every product and just about every plant.

We have since added some capacity so that we don't have that problem any time soon. But -- so we came down in sales 15%, so in general term, we're moving back up in that zone. But again, we can have individual projects that are tight on capacity and some that have excess.

Alright. Thank you.

Ken Herbert, Wedbush Securities.

Just wanted to maybe look at that from a slightly different perspective. It looks like the incremental margin within composite, the composite materials segment, was obviously very strong in the second quarter. Is that -- and I know you've talked about, for the Company, sort of a 20%, 25%. As you're in the sweet spot that you're now, or maybe you're not having to look at adding headcount or other costs as much, what kind of run rate are you looking at on the incremental margin, specifically within composite materials?

Let me ask a couple of clarifying questions back to you. Are you talking about year-over-year or sequentially? And are you talking about operating or gross?

Sequentially on the operating line.

I would normally caution people against doing a sequential calculation, particularly on the operating line, because of seasonal factors. On a gross margin line, maybe you can, but seasonally, it's pretty dangerous to do that. I like to do year-over-year because it's the same quarter and it's got the same ramp-up or shutdown periods and so forth.

I still like to see 20% operating leverage year-over-year in both businesses; expect that we can do it. It bounces around quite a bit, but over the long haul, that's what we should be able to do. The exception was 2008 when we were struggling with capacity and had five new startup plants. And I'd like to not have that happen again. I really hope that if we get to the volumes that we had in 2008, we'd be delivering a lot better operating income.

Okay. Are you facing, any time in the next sort of six to 12 months, any material step-up in the operating expenses, either from -- as volumes continue to ramp, as you look at the gross -- growth across the organization from either -- from the variable cost standpoint, in particular? Or anything we should be thinking about from that standpoint?

Well, I think we do a pretty good job of managing raw material exposures with back-to-back contracts or -- contracts that are longer-term rather than volatile. We don't control every commodity. Acrylonitrile is one, for instance, that moves around quite a bit and affects our carbon fiber costs. Those costs are rising.

Utilities is another one we don't have complete control over. And those are pretty stable at a natural gas level but are likely going to start creeping up, as oil does, and some of the other elements in transportation. But in general, we have had good variable margins for six months in a row through a combination of lots of pieces and parts -- no special one-timers; no special magic golf ball or new clubs. We just hit a lot of fairways and didn't three-putt any. So I'm hopeful we're going to be able to continue this.

Okay. Very good. And then just finally, one follow-up on the wind side. It seems like -- and based on what you said earlier, nothing unusual in the quarter; just you're back to sort of normalized volumes there as that continues to ramp. Just remind me again about the lead-times in that business. And you say that cycles seemed to be shortening, obviously, but what are the lead-times you're typically faced -- facing?

Well, in our prepreg business, for almost all customers, it's a very narrow band. It's a full system because our materials have to be kept in a freezer. So we don't get big blanket orders that we fill. We ship when they need it. So when I was talking about lead-times, I was talking about the backlog at Vestas or Gamesa, the big prepreg users. Their backlogs are lower than they have been in the past.

Two or three years ago, there wasn't enough capacity to deliver wind turbines and backlog is built up pretty high. Today, they're pretty close. So, Vestas announcing this big order in the US and saying that half of it was going to be shipped yet this year, gives you a sense that they're running pretty close between order and delivery. So to the extent we ship as they make the blades, it's a pretty tight supply chain today.

Very good. Thank you very much. Great quarter.

Peter Cozzone, KeyBanc Capital Markets.

Great quarter. On the wind business, can you talk about maybe the monthly trends in that in the second quarter? Any, I guess, sequential pickup as the quarter progressed? And maybe an update on kind of how it's holding up in July thus far.

Well, we don't normally give monthly numbers and I wouldn't be comfortable disclosing a mid-quarter point. I think the main thing I recall is that last year, we had -- the second quarter started out strong and then tailed off at the end. So, we have easier comps in the third and fourth quarter for sure and I don't think there are going to be big swings, as we see things right now.

Our customers have a certain number of blade molds. They try to run them a certain number of days a week and we have matching capacity to go with it. So, they can't double their output easily; they need to add molds and it takes some time. They can, as we saw in the first quarter, stock mold and not run the plants, but we're, again, projecting that the second half is going to be kind of lackluster, maybe up a little bit from last year, but no big movement either way.

Okay. And then maybe more generally speaking as far as trends, given Vestas's recent activity in the North American market, maybe what you're seeing in terms of benefit from the US market, and maybe your outlook longer-term versus some of the other markets you ship to.

Well, the European market has been -- is the oldest market. It's been running for a long time. There's a lot of support in the EU for renewable energy. A lot of commitments that they've made with penalties if they don't get there. So the European market has always been a pretty steady, good producer for us. The US has been the fastest-growing market in many of recent years, though the Vestas share of that has not been large. So we're happy to see that they're penetrating in the US and hope that's the start of a trend.

China is now the biggest and the fastest-growing, but pretty erratic rules being put out by the government and it's a bit of a wild card that we don't have our arms around.

Okay. And there's one more on FX -- could you maybe provide some more color on the impact in the second quarter? And is there any rule of thumb we can apply in regards to maybe a 1% move in the euro? Or I guess maybe another way of asking it is, if current rates hold up, what are your expectations as far as EPS impact on the full year?

Yes. With respect to the second quarter, FX contributed about 50 basis points of the operating income versus last year. Our total exposure in a year to both the euro and the pound is about $100 million at the operating income line. But when you look at it for the rest of 2010, almost all that has either been hedged or has already occurred. And so any additional movements between now and the end of the year probably won't have much effect on our operating income dollars.

Now, obviously, if it carries over into 2011, it will start to impact us there. But we already have about half of the exposure hedged for next year.

And of course, it could affect our percentages.

Right, the (multiple speakers) --

-- change the top line.

The operating income dollar line is not likely to change, but the percentage will change because the sales will move, but the operating income will hold the same as a result of our hedges in place.

Great, that's helpful. Thank you, guys.

Avinash Kant, D.A. Davidson & Co.

This is Eric Ramos in for Avinash. What is your dollar content for the Boeing 777?

We don't disclose that, but it's less than the 787. It's -- I mean, the generation, whatever is the most recent airplane, it's better than the previous airplane. So it's the prior airplane to the 787. So it's a real good program for us but not a size of the 787, that is averaging $1.5 million.

Okay, thank you. And what do you expect Capex and depreciation to be for 2010?

We've said we're going to stay below $75 million for Capex. We'll need to start ramping up in the second half -- back for the growth.

Depreciation expense will probably be in the $55 million range.

Alright, great. Thank you.

Our final question today comes from Dan Whalen with CapStone Investments.

Last year (multiple speakers) -- we've seen revenue from new aircraft programs as a percent of commercial aerospace revenue essentially double. Any estimates or color you can provide in terms of where that number could be in a year or two?

Well, I haven't done the math on what the build rates are going to be in a year or two, but if the A380 gets up to 30 or 35 aircraft per year times $3.3 million, that's, what, [100]? And the 787 -- pick out a line rate, if it gets to [100] a year, that's $1.5 million, that's another $150 million.

A350 isn't going to be big in a couple of years, it will be in probably three. So, I don't know -- somebody do the math. What'd I get? Roughly [$250 million], say [$300 million] on top of today's commercial aerospace base of -- [to] waiting on it per year --

Yes, so -- yes, I guess --

It could get to 50%?

[A dollar's] per ship set on all those programs, so really, you can make your own assumptions on how quickly you think it will ramp up.

Did you say 50%?

Well, I was just trying to do -- no, I didn't. I guess I didn't.

It's just -- we're just saying -- we've given out the dollars per ship set and you can pick your own point in time.

I just want to roughly get your view on that. And just try with this one, but just looking at old programs versus new programs, any rough color you can give in terms of the margin delta?

No, we don't have wide ranges of margin across our businesses. They're all sort of in the same neighborhood and I wouldn't say there's a big swing one way or the other.

Between new programs and old programs?

Right. Correct.

Great. Thank you.

That concludes our conference for today. Thank you for your participation.