Hexcel Corp (HXL) 2010 Q3 法說會逐字稿

Good day, everyone and welcome to this Hexcel Corporation third-quarter 2010 earnings release 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.

Good morning, everyone. Welcome to Hexcel Corporation's 2010 third-quarter earnings conference call on October 26, 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 third-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 rebroadcast without our expressed 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 third-quarter results detailed in our press release issued yesterday. First, Dave will cover the markets and then I will cover some financial details before taking your questions.

Thanks, Wayne. Third-quarter revenues of $294.5 million were up 14.5% from 2009 or about 18% higher if you adjust to a constant currency comparison. While seasonality typically results in lower gross and EBIT margin rates in the second half of the year, our 23.9% gross margin and our 11.7% operating income rate were the best for a third quarter in over a decade. Operating income of $34.5 million was almost twice last year's adjusted $17.9 million for the third quarter. Likewise, adjusted for one-time items, diluted earnings per share of $0.20 was double last year's $0.10 per share.

Now let me cover the markets using constant dollars to describe sales trends. Commercial aerospace sales were $158 million for the quarter, up 26.1% in constant currency from last year's third quarter with good growth from both legacy platforms and the new Boeing and Airbus programs. Total revenues to new programs, which include the A380, 787, 747-8, and the A350, doubled for the quarter as compared to last year and accounted for more than 20% of our commercial aerospace sales for the second quarter in a row.

Sales to other commercial aerospace, which includes regional and business aircraft, were more than 10% higher than the low point reached in last year's third quarter, but slightly below the second-quarter level. Sales to space and defense markets were up about 2% on a constant currency basis versus the third quarter of 2009.

As with the last quarter, growth in composites for rotorcraft, especially the ramp-up of the V-22 Osprey program, have more than offset the decline from the wind-down of the F-22 program. The F-22 step-down began in the fourth quarter of 2009, so comparisons will be easier going forward.

In industrial markets, sales were $62.5 million, up almost 22% in constant currency versus last year. Wind energy sales were up more than 20% over last year's low third quarter, but about the same as the second quarter of 2010.

We are encouraged by the pace of Vestas order announcements this year, but continue to be cautious about the timing and pace of a return to growth in the near term. Industrial sales, excluding wind, were also solidly up year over year for the first time in over three years as the completion of our portfolio pruning and the delay of USEC's American centrifuge program are now more than four quarters behind us. Now let me turn the call back to Wayne for some additional comments on our financials.

Thanks, Dave. As Dave pointed out, our adjusted diluted earnings per share was $0.20, twice the $0.10 per share we reported a year ago. Year to date, we are now at $0.58 per share, about 12% higher than last year's $0.52 per share on year-to-date sales that are about 3% higher in constant currency.

Gross margin of about $70 million for the quarter was 23.9% of sales, 360 basis points greater than a year ago. The improvement reflects the higher sales volume, factory productivity and cost reduction initiatives and favorable product mix. In addition, exchange rates contributed about 50 basis points to the improvement, which was enough to offset the $1.3 million step up in depreciation expense included in cost of sales.

Selling, general and administrative expenses for the quarter were $28.7 million, or $2.9 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 $7.3 million, about $1 million lower than last year, reflecting last year's high development qualification costs for new commercial aerospace programs. Year to date, research and technology costs are just higher than last year.

So our operating income for the quarter was $34.5 million, or 11.7% of sales as compared to adjusted operating income of $17.9 million, or 7% a year ago.

Interest expense for the quarter was $5.3 million compared to $6.9 million last year. This was due to both lower interest rates and lower average borrowings outstanding.

As we reminded you in the release, on July 9, we successfully refinanced our senior credit facilities, which lowered our initial 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 by more than $5 million in the first year at current borrowing levels and forecasted LIBOR rates. And the payback on the $3.7 million of refinancing costs should be about nine months.

This quarter included the previously announced charge of $6.8 million for the accelerated amortization of the deferred financing costs of the old facility. After tax, this was $0.04 per share and is the only one-time item we excluded in our adjusted earnings calculation for this quarter.

Our year-to-date effective tax rate was 30.7%, excluding the benefits of special tax credits earlier in the year, which is in line with our expectations. As most of you know, a weak dollar against the euro and the British pound hurts us. We now have our euro and British pound exposure at the operating income line close to being fully hedged for the year, so further movements will not significantly impact our 2010 operating income dollars.

However, continued weakness in the US dollar will increase our sales with no change to our operating income dollars, so will have a negative impact on our operating income percentage. So for the rest of this year, about every 5% weakening of the dollar results in a 15 to 20 basis point drop in operating income percentage.

Our free cash flow for the first nine months of the year was about $38 million as compared to last year's $58 million. Our higher sales and improved outlook resulted in about a $73 million net increase in working capital year to date as compared to 2009, but capital expenditures were $51 million lower than last year.

While our accrued capital expenditures for the first nine months of 2010 and were only $24 million, we do expect the pace of spend to increase in the fourth quarter with the full-year range for accrued capital expenditures now expected to be $60 million to $65 million. Our total debt net of cash now stands at $253 million, the lowest level since 1996.

Lastly, I hope all of you appreciate that we made our diluted earnings per share calculation easy this quarter by having a diluted share count that is exactly 100 million shares. So now let me turn the call over to the operator to take your call.

(Operator Instructions). David Strauss, UBS.

Good morning. It looks like CapEx is running a little bit below your initial expectation for this year and you have guidance for the next couple of years in the $150 million to $200 million ranges. Does that range still hold?

Yes, it does. If programs stay on schedule and the ramp rates go up, as we currently project, we need to be adding capacity in anticipation of that.

Okay. And then, Wayne, you talked about currency for '10. Can you give us an idea on '11 and what kind of -- how much you are hedged on '11 and what kind of headwind could we be looking at given any of the weakening in the dollar that we have seen recently?

Dave, I will just comment really on our hedge rate for next year versus this year. We probably are 50% to 60% hedged for next year and the rates are about the same as this year.

Okay, all right. Thanks, guys.

Howard Rubel, Jefferies.

Thank you. One of your or your largest wind customer provided some cautionary outlook I think today. David, how are you prepared to deal with those challenges?

So for those of you who haven't seen it, Vestas released earnings this morning. They are our biggest wind customer. I skimmed through their 35-page press release and some of the key takeaways that I highlight, just to catch everybody on the call up and then I will answer your question, Howard. Their nine-month year-to-date order backlog is at 6.6 gigawatts, which is a record for them. In fact, it is greater than the last two years combined. Their backlog stands at 5.9 gigawatt, which is about a year's worth of production.

They gave guidance on 2011 shipments of 6 gigawatt, which is similar to last year and I don't know -- I didn't see what they said they are going to do this year, but I take that as an encouraging sign that they still think they are going to have that kind of a shipment rate next year. They are projecting 2011 orders to be in the 7 to 8 gigawatt range, so they expect to build backlog next year, which bodes well for 2012.

They also still expect for this year that their orders will be 50% European, 30% US and 20% Asian and they have been emphasizing for some time now this in region for the region policy that they have whereas they want to be manufacturing in the location that they ship to. As you know, they have built two new blade plants in the US, two new blade plants in China in recent years. They have five European blade plants and they did announce that one of the smaller of their two Danish plants is going to be closed down because of the added capacity in region.

So it has yet to be determined what impact it has on us. We, of course, built our plants in China and Colorado to follow them. I think their assumption was that the growth in Europe would allow them to backfill the capacity that they freed up in Europe. And now it looks like they are thinking they can't do that, but they clearly are trying to minimize their headcount and their dependency on Danish facilities, which they call their highest cost facilities.

So at this stage, I don't see anything particularly disturbing or different in this release. I am, as we have pointed out in the release, still concerned about the return to growth in wind. I am not as optimistic about it snapping back as we might have been a year and a half ago. However, I continue to be encouraged by Vestas' pace of orders. It looks to me like they are gaining quite a bit of share, particularly in the US.

And if I am not mistaken, wind is still around 50% of industrial, is that right, David?

We have said it is over 50% of industrial. That is as specific, Howard. It still is.

And then just one other question, I am trying to understand this. You talk about higher operating income baseline from which we will target incremental operating margins of over 20% on a year-over-year sales growth. That is what you're really talking about beyond 2010 in terms of your -- beyond 2010?

Correct. Howard, I think I confused some people when I kept talking in the spring about 20% leverage because we obviously are well beyond that this year. I think we are at close to 40% year-to-date operating income leverage on the incremental sales. So I just wanted to clarify that we are talking about beyond this year.

So we are establishing a higher level year-to-date adjusted operating income, as you have probably seen, as 11.9%, which actually is just about even with the record of the '97, '98 peak in the past. Likewise, gross margins year to date are at 24.9%. So we are trying to establish that this is the base level from which we hope to get 20% plus leverage going forward.

Just a pushback on that, because if you have 24% gross margins or thereabout, each incremental sales dollar should be in that range as opposed to just 20%. Are you giving yourself some wiggle room for development?

I love the way you think, Howard. You sound just like me talking to my people. I mean, theoretically, I say anything -- any increment on gross margin, we want to get all the way to the bottom line. Anything else is leakage. Of course, you do have inflation and certain other things that need to be taken care of, but I like the way you think.

Thank you.

Ronald Epstein, Bank of America-Merrill Lynch.

Hey, good morning. I've got I guess a big picture question for you. Bombardier is using more I guess aluminum lithium on the C series and if we were to see more migration towards aluminum lithium on future airframes, is that an opportunity or a competitor for carbon fiber composite?

That is a competitor and that is aluminum lithium and carbon composite displacing conventional aluminums. So it's the fuselage or parts of the fuselage. In fact, many new aircraft are starting to use more aluminum lithium. It is a lighter weight alloy. So aluminum's response to composites and titanium was to introduce a more user-friendly aluminum lithium and probably better pricing. But that is not the market we are in.

Okay, great. Thanks.

Steve Levenson.

Thanks, good morning, everybody. Nice round share count number too. Can you give us an update on what you are hearing about A350, please?

A350 is a big, big project for us and everybody involved, all the Tier 1s and 2s are starting to do their development work to make components and I think most of the shares have been parsed out. Most of the work packages are assigned. So for Hexcel, it is a big tech services project where we now are needing to support all these customers with our newest prepreg system. I don't have a lot more to say than that other than it is a lot of work with not a lot of sales yet.

Right. Well, presumably that will come over time, but do you have any expectation of both what you have been saying in the past as your content per chipset?

We haven't really clarified anything beyond the primary structural prepreg, which I think we have sort of indicated is $3 million plus. It is a little early to be defining all the other pieces and parts and materials that we might have on it. But the primary structural prepreg is all we have really declared so far, Steve.

Okay, thanks and last, any update on USEC? It seems like there is some activity where some people are optimistic about their getting a loan guarantee and resuming work on the centrifuge plant. (multiple speakers)

Well, I am hopeful. I don't know how to handicap it, but I am certainly hopeful because we would love to see the project go forward. Last I understood that they hoped to re-approach and resubmit with -- I am sorry -- they have resubmitted and they hope to get a response from the DOE by the end of the year and then it will take them a few months to get the financing in place and get launched. The sales impact for us would likely be the year following any such announcement.

Okay, thanks very much.

Noah Poponak, Goldman Sachs.

Hi, good morning. I just want to follow onto Howard's question on the incrementals. I don't know if I have a better way of asking this or not, but they are just much stronger than what we have talked about and I guess they tend to be stronger earlier in the recovery, but this is a high fixed cost volume-driven business and you did a lot of cost take-out productivity initiatives during the downturn. Why can't they sustain at something much better than 20% as we move forward?

Well, as Howard pointed out, you kind of start with gross margins. So if gross margins are in the 24%, 25% range, that is not the absolute cap, but that is normally the starting point for any kind of leverage. They were big this year in part because of the productivity gains, but also last year had a dramatic drop in volumes that was sudden, unexpected and so it took quite a while to course correct. So I kind of consider the incremental leverage we had this year as too easy to count. It is not a good comparison. Last year's operating income in the third quarter was 7%. We haven't seen a number like that in five years. So when we say 20% plus, we hope that, with improved mix and a good leverage on the new plants and cost controls, that we will be able to do more than 20%. We are just not ready to sign up for a higher number yet.

Okay. And on 787, maybe just an update on what you are feeling or not feeling pull there. I think in recent quarters you have kind of talked about how that has felt and we continue to see news come across the tape that things are a little slow there. What are you seeing on 787?

Well, we have probably 30 or 35 ship-tos now on 787 as you get down to Tier 1, Tier 2s and Tier 3s. So it is pretty hard to be specific. I would say, as we indicated in the press release, that there seems to be a little movement with respect to delivery requests from one month to the next, a little jostling going on, which is why we just sort of cautioned a little bit about fourth quarter having the kind of blow-out growth that we showed this quarter.

It could be some realignment of 787 ramp-up. It could be just year-end inventory management by customers. Nothing real big, just a little bit of rearranging of the deck chairs it seems to me so far. We are still encouraged that the ramp is going to be pretty serious going forward and you add to that the build rate increases that have been announced on almost every program, on the legacy programs at both Airbus and Boeing. We are still highly confident of double-digit growth next year.

Okay. Thanks a lot.

Ken Herbert, Wedbush Securities.

Yes, hi. Good morning. Just first, when you talked about the slowdown or the moderation of some of the growth in the fourth quarter, would you attribute more of that relative to your expectations from wind or from commercial aerospace?

I don't know that I have an answer for you on that. We just have seen some rearrangement that is either around inventory management or program timing. Again, not major. We are looking at maybe sort of a flattish looking fourth quarter to third and if you do the year-over-year comps, last year was, I think, particularly low. So we just wanted to -- we feel great about this 18% growth we had and I am just not sure we are going to put up two of those in a row.

Yes, Okay. Okay, no, that's good. Specifically on the wind, have you heard anything so far into this quarter from your primary customer about any slowdown in shipments into them?

We have regular weekly meetings on requirements to each of their nine plants that we serve. So we are hearing things all the time, but what I said at the top level is about as detailed as I would want to get on it for confidentiality reasons.

Okay, okay, that's good. Just shifting gears then, if you look at the slight uptick in inventory in the quarter, still seems fairly manageable. Can you comment just on expectations for the full year and the fourth quarter specifically then in terms of inventory and working capital?

I think my operations people -- I wouldn't want them to hear you think it is a slight uptick. We've clearly put up quite a bit of inventory this year and I am not comfortable with the pace of growth. Some of it is unique. Some is because of the schedule changes that I referred to, some is strategic inventory, particularly on carbon fiber to a cost trade with CapEx timing, which we have been able to reduce because of that inventory. Some of our products now have a longer supply chain as we have become a little more vertical on new products. But at the end of the day, I think our inventories are higher than we should be and I really would like to see them down $15 million or $20 million in the fourth quarter.

Okay. So that sounds like a realistic target then for the quarter and where to end the full year. Just finally the, on the 787, is there any point you can point to in 2011 that you would identify as a potential inflection point where maybe volumes potentially step up materially or do you envision it as the ramp under the current plan as fairly a smooth and gradual step throughout 2011 and into 2012?

Generally, our new programs, because of the diversity of customers and ship-tos, we end up having a pretty steady slow ramp, not any radical step and I am sure the whole supply chain is going to try to ramp up in an orderly fashion. So I wouldn't expect any big inflection points.

Okay, thank you very much.

Michael Lew, Needham & Co.

Thank you and good morning. You had highlighted Vestas. Could you also comment on Gamesa? Are you seeing any signs of pick up there?

I think Gamesa's order pattern seems to be a little bit softer than Vestas and they also seem to be backing off on some of the European operations. Likely all of the big wind turbine makers who are normally or historically based in Europe will be shedding some capacity in Europe as the growth in recent months has been in China and the US.

Okay, and are you close to signing any new customers or any new supply agreements in the near term for any customers, new customers in wind?

We don't have any announcements prepared.

Okay. And recently, it was highlighted that Airbus's A380 is starting to carve out a new market with direct travel to non-hub cities. Are you seeing any signs or experiencing any increase in demand associated with that program, which is obviously more composite-intensive?

Yes, well, the A380 is starting to get some traction. We, for years, had seen very little activity because so much material was shipped and so many parts were made before they had their production problems. But that inventory seems to have cleared now and we are starting to see steady demand and gradual growth in A380. I think we've pointed out last quarter that all new programs had growth and that included the A380.

Are you seeing any let's say unexpected acceleration or better than anticipated pickup?

Since you don't know my calibration with respect to anticipation, I am not sure that's -- I don't have anything to say on that.

Sure. Okay. And you had highlighted next year you expect to be at 16 million pounds of nameplate capacity. What is the current capacity level for carbon fiber or can you [most] talk about the utilization rate?

Yes, Michael, right now, we are at about 10 million pounds and we should get to 16 million by the end of next year.

Okay, thank you.

[Pierre Cazone], KeyBanc.

Good morning, guys. Will you incur any additional costs as the 787 and A350 ramp up here and have you brought back any variable costs from the downturn? Is so, maybe could you quantify these and maybe your expectations for incremental costs heading into fiscal year '11?

Well, variable cost goes directly with sales. So if we have a sales increase, we bring in more raw material and to the extent we need labor for it, we provide labor. So I would expect variable always to track directly with sales. And as for fixed costs, we had to add quite a bit of capacity with our five new plants in 2007 and '08. Those are in place now and while we will be putting additional capacity and staffing in as those plants start to ramp up to support A350 and wind, we will obviously be adding some fixed costs. But I think our leverage should be better than it was in 2008 because we have got the plants established now and have the footprint in place.

Okay, and then on the R&D side, do you expect any step-up there in 2011 as far as new products related to some of these new commercial platforms or can we expect kind of this similar quarterly run rate as we have seen here in 3Q?

Well, we have gone through it a little bit quarter to quarter, but I think generally we expect something in the 2.5% to 3% band to be typical going forward unless there is some brand new products that require significant internal investment. We don't have any such things lined up right now.

Okay. And then one last one here on -- do you sense we are in kind of the early stages of recovery in the regional business jet market and I guess do you think kind of 3Q trends persist going forward?

I think the regional and business jet market is just starting to show some signs of life at the end customer level. If you read what was said at NBAA, it does seem to be a little bit stronger with the bigger aircraft, whether it is business jet or regional jets, which tend to be a little bit more composite-intensive. But I think it will be a while before we see a significant recovery in that market. I don't know if it gets back ever to what it was before. The $100 million run rate for the other commercial aerospace that we have given guidance on before still seems like the right kind of number to have as a placeholder.

Okay, great. Thank you very much.

Howard Rubel, Jefferies.

Thank you very much. Wayne, is there any additional clean energy tax breaks that you are going to be able to take advantage of?

Howard, we have the rights to some, but we would have to put capital expenditures in I think in the next year or two and there is probably nothing we would count on just yet. Just have to see how the market grows, but we potentially have some available.

Thank you.

That concludes the question-and-answer session, as well as today's conference. We thank you for your participation.

Thanks.