Hexcel Corp (HXL) 2012 Q2 法說會逐字稿

Good day, and welcome to the Hexcel Corporation Second-Quarter Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Wayne Pensky, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

Great, thank you. Good morning, everyone. Welcome to Hexcel Corporation's 2012 Second-Quarter Earnings Conference Call on July 24, 2012. 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 2011 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 re-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; Nick Stanage, our President and Chief Operating Officer; and Michael Bacal, our Communications and Investor Relations Manager. The purpose of the call is to review our 2012 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, and then we'll take your questions.

Thanks, Wayne. Good morning, everyone. We had another great quarter with sales up $399 million, up over last year by about 16% on a constant currency basis, or 13% as reported. Sequentially, second-quarter sales looked a lot like the first quarter, but with even better margins. Plus, we had some one-time items that combined to add $0.05 to our EPS. Adjusting out the one-time items from both periods, diluted EPS of $0.42 was 31% better than 2011. Thanks to our good execution and strong conversion on incremental sales, we improved our adjusted operating income to 16.1%. This was a 210-basis-point improvement over the second quarter of 2011, with only 30 basis points coming from favorable currency impacts. We again set Company records this quarter for the highest operating income dollars and percent and for adjusted net income.

Now, let me cover the markets using constant dollars to describe the trends. Commercial aerospace of $233.5 million for the quarter were up over 14% in constant currency from 2011, with growth in each of our sub-markets. Total revenues from new programs increased by more than 30% for the quarter versus the prior year, and now account for about 30% of our total commercial aerospace sales. Sales for legacy platforms at Airbus and Boeing were up modestly from the second quarter of 2011, but lower sequentially as sales rates moved back in line with aircraft production levels. Sales to other commercial aerospace, which includes regional and business aircraft, were up over 10% compared to the prior year, but also slightly down sequentially.

Space and defense revenues were $88.1 million, up about 10% on a constant currency basis versus the second quarter of 2011 and up almost 4% from the first quarter. Growth in rotorcraft continues to be the primary driver. In industrial markets, sales for the quarter were $77.6 million, up about 28% year over year in constant currency. Wind sales were up significantly over an easy comparison to last year's second quarter, and they have now grown sequentially for the last six quarters. While we're encouraged by this growth in the large backlog of turbines on order with our largest customer, our guidance for the year assumes a second half similar to the second half of 2011 due to economic and policy uncertainties. Now let me turn it back over to Wayne for some additional comments on the financials.

Thanks, Dave. Gross margin of $105.5 million for the quarter was 26.4% of sales as compared to 24.6% in the second quarter of 2011, due to good leverage and the strong sales volume and favorable impact of exchange rates. SG&A and R&T costs grew less than revenues and thus improved to 10.3% of sales. Our foreign exchange rates contributed about 30 basis points to the higher operating income percentage in the quarter as compared to last year, and about 40 basis points to the year-to-date operating income percentage. Our operating leverage continues to be strong. After adjusting for exchange rates, we delivered 28% in incremental operating income on the sales growth for the quarter and 26% for the first half of the year.

Additionally during the quarter, we experienced three one-time events that impacted reported operating income as presented in table C of last night's press release. They netted to $9.5 million of income and consisted of -- $9.6 million in income from settling our business interruption insurance claim arising from the April 2011 tornado that hit our Alabama Pan facility; a gain of $4.9 million from the sale of land in Livermore, California, the site of a previously closed manufacturing facility; and, lastly, a $5 million in charges to the environmental reserves, primarily for remediation of a manufacturing facility in Lodi, New Jersey, that was sold in 1996 -- excuse me, 1986. As you may recall, during the second quarter, we redeemed the remaining $73.5 million of our 6.75% senior subordinated notes, which resulted in a $1.1 million charge, or $0.01 per share, from the accelerated amortization of deferred financing costs and expensing of the call premium. The redemption was funded by a $75 million add-on to our senior secured credit facility.

Our year-to-date effective tax rate was 31.8%, which is in line with our guidance and about the same as last year's tax rate after excluding one time benefits. Our free cash flow in 2012's first half was a use of $71 million as compared to a source of $9.5 million in 2011. This reflects an increased capital spending for ongoing capacity increases. In the first half of 2012, we paid cash of $144 million for capital expenditures, as compared to $68 million in 2011. We are still targeting to spend between $250 million and $275 million for capital expenditures this year, and we expect our capital spending to be funded by our cash from operating activities and our exiting credit facilities. We estimate we'll use between $50 million and $75 million cash for the full year of 2012. We would now be happy to take your questions.

Thank you.

(Operator Instructions)

Steve Levenson with Stifel Nicolaus.

Thanks, good morning everybody.

Hello Steve.

I'm sure get lots of questions about the margins afterwards, but I figured I'd ask about some of the new products. On A350, do the potential delays like the drilling machine issue that's been widely reported have an impact on your schedule, or do think you can stick to what you anticipated at the start of the year?

Well, as I've said before, I'm not going to front run the customer. But as you may have seen, the whole front fuselage for the first flight aircraft was to lose this month. If you haven't seen it, it's on the Airbus website, the picture of it. And yet it's had some difficulties with the mounting holes on the wing.

But at the Farm Grow Air Show last week the Airbus CEO said the most critical phase, the assembly, is behind them. Also at the show, you certainly noticed that [Cafe] became the launch customer for the A350-1000. The new larger version of the A350 scheduled to be introduced two years behind the dash 900, so that's great news.

But as for timing, also again quoting Fabrice Bregier the CEO of Airbus, he told the Financial Times that the schedule was challenging but achievable. And then a point that he made that I do want to quote, is he said let me put it this way, we'll do better than the market consensus. So I guess the real question is what the market's assumed, and how will their performance compared to that.

As for us, we're tracking -- paying very close attention to them. We're very tightly intertwined with their program team, and we make adjustments that we need to. Right now, I don't see any big changes in what we expected as we came into the year and we're pretty pleased with what we seeing here.

Sounds good, thank you. And the second item is something coming out of Rolls Royce and GKN. I guess in order to compete, they're looking at making a composite fan blade for some of their new engines as well as a composite fan case. Is there anything you can tell us about Hexcel's involvement there please?

Well we're involved with all of the engine makers, all of the nacelle makers, and all of the airplane makers. So, if there's composite work going on, you can put us down for being involved. Rolls Royce and Pratt Whitney have long studied fan and have only been interested in increasing composites in the case.

GE has obviously taken the lead in that from the mid- 90s on the GE 90. Whether that ends up being a fact in the fan, it remains to be seen. But we're working on development programs with all of them.

Okay. And do you think you have an edge over the other guys, as you're the only ones right now in the engine materials business?

Well, I always like to think we have an edge, Steve. And the materials are -- composite material systems our about performance of the materials. They're not unique necessarily to what part of the engine or what part of the nacelle, though we have certainly the broadest range of products. So, we're more likely to have a range of products that can interest engine and nacelle people when they're trying to reduce weight.

Got it, thank you very much.

John McNulty with Credit Suisse.

Hello, this is Abhi Rajendran calling in for John. A couple of quick questions. Morning.

Your margins are now at record levels. So, I was just wondering how we should think about for the potential for them to push higher from here, and maybe you could remind us of some of your longer-term goals for margins?

Well, as you note, we've had some pretty darn good margins. In fact, for four quarters in a row, Nick Stanage and his operation team have embarrassed me by delivering more leverage than I expected.

I was looking this morning, the LTM leverage is now over 30% operating income on the incremental growth, well above my 20% plus guidance. In addition to SG&A cost control, we've had over 35% gross margin leverage over the last 12 months. We've had some help from the strengthening dollar, lower AN prices and natural gas prices, but factory performance has also been outstanding. So, hats off to the operations team.

As for taking up the guidance, I still want to stick with the 20% plus EBIT leverage guidance. We have new line start ups, timing of certain programs that always worry me a little bit, but, I guess I could say we can comfortably be over 20% plus. Some of you know I'm a struggling golfer, I kind of feel like I've had two birdies in a row and my knees are knocking on the next tee. So, we'd like to continue to outperform our 20% plus expectation.

Got it. And then a quick question on commercial aerospace. So the 12.5% growth that you put up in the quarter was obviously a little bit less than the 20% or 30% growth you've seen in over the last several quarters. How should we think about growth in that segment throughout the rest of the year?

Well, I think new programs will continue to grow as far as the eye can see. As long as there are more programs in the pipeline.

So as I've said before, you have a A380, 747-8 that are hitting stride now. 787 is starting to climb and really record some nice year-over-year gains. A350 is growing nicely, and certainly will grow dramatically after the 787 does. And then the new engineering programs for A320 followed by the new engineering on the 737. So that segment which is now up 30% of commercial aerospace you can expect darn good growth and it's of course on a bigger and bigger number.

The Legacy Aerospace we mentioned on the last call, it was running a little hot in the last couple of quarters. It seemed to us that our sales to Legacy were higher than line rates would suggest. And we attributed that to inventory restocking after the big downdraft of inventory through the whole supply chain in 2009/2010.

If this quarter is any indication, we've got that behind us now and now we think we're properly aligned with the current build rates. And we should start to see a line rate based increases going forward, which look to be in the 6% to 10% per year range according to the current announced rates.

As for the other commercial aerospace, it's always a bit of a wild card. It seems to have settled it in the $140 million to $160 million per year run rate. Until there's a pretty strong recovery in the economy, I wouldn't expect that to get back to the $200 million rate that we used to see.

Okay great. And then one last question if I may, on the wind side of the business, you're looking for a sequential slowdown in the second half. I guess beyond general macro uncertainties and some potential financing issues, how should we think about the environment for subsidies and credits for wind projects on a global basis beyond this year?

Well, I know a lot of people are worried about the US production tax credit and there's an awful lot of press coming out of all the wind turbine makers trying to urge Congress and the administration to make a move on the PTC. I'd say even if the PTC is extended, you're going to have a slowdown in US inflation's in 2013 just because of the cycle that it takes.

I think you shouldn't get too focused on the PTC as far as Hexcel sales go. Hexcel sales are principally to Vestas. They're very diverse in their backlog. Their US orders in the last year have been less than 20% -- last two years, less than 20% of their order backlog.

And while I do worry about low natural gas costs or credit in Europe, or lower demand or grid problems in China, the fact is in the last 12 months, Vestas has still kept up an order pace. Their announced orders, firm orders for the last 12 months are 6.5 gigawatts. That's 25% higher than their 2011 delivery rate. So, their book-to-bill must still look pretty good, and they had a backlog coming into it.

Now, I don't know what goes on with cancellations and push outs underneath the covers, but the fact is our customer seems to be doing pretty well. And thus, we've had quarters of growth. Our outlook for the second half is more a matter of being conservative because of the uncertainties than it is a lack of confidence in the backlog that Vestas has accumulated.

Okay, great. Thanks very much for the color.

Emmett Muraqba with Deutsche Bank.

Great. Thank for taking my question. And then congrats on your new position.

Dave or Nick, they can you comment on the operating leverage in the wind business, specifically on the downside? If wind were to take a step function change down, how should we think about the decremental margins in that business before and after any cost reductions?

Well, I would say leverage on the way up is always easy. Minimizing the leverage on the way down is always hard, but we've been doing it for 11 years. Sadly, we've had a couple of experiences after September 11 and with the electronics meltdown, and in fact we had a pretty serious drop in wind three or four years ago. So, if you look at 2009, 2010, we don't break wind out for you so I can't answer your question specifically.

But we got good favorable leverage this year because we have these new plants in the US and China. And as we started to fill them up and use them, we had real good increments on wind even though it is a lower margin product line than the rest of our businesses. It's an incremental world, so, I think you can count on Nick and his team to manage what cutbacks need to be made if there is a slowdown. But again as I say, I don't see -- I really don't see trouble in the next two to four to six quarters in wind.

So $1 of sales loss in wind on an incremental profit basis would equal more or less? Or would it be directionally less or directionally more than $1 loss -- incremental loss on the commercial aerospace side of the business?

I guess I'll dodge that by saying it sort of depends on what region the sales decline is. If it's equally across all regions and I've got three plants then running inefficiently versus a serious slowdown in one where we can shift work and be more efficient. How is that for a dodge?

Okay, I'll try another question. Can you just update us on the A380? Are the shipments currently at the run rate of the most recent production slowdown or will there believe some sequential headwind on that program as you meet the slowdown that Airbus has announced?

If I had to make a worry list, it's a short list. But I don't think we've seen as much of a slowdown. I do think the step down is proportional to what build rates have happened.

What I'm a little bit worried about is if there's going to be an inventory correction because of that slowdown. If there is, we haven't seen that yet. The first and second quarter comparisons would suggest that it's an orderly slowdown in anticipation of going back up. But I'm not sure we've seen all the cards on that. So, I think I'd have a better answer for you in another quarter or two, and then I think we'll certainly be stabilized.

Okay, just one last quick question and then I'll hop off. Just on cash flow looking in 2013, I know you don't have guidance, but if we just look at the moving parts, earnings should be up $20 million to $25 million, DNA will be up another maybe $10 million, CapEx probably stays where it is for another year. That gets you to about a $20 million to $25 million cash flow burn for next year, assuming sort of the similar working capital investment for this year. Is that in the ballpark, or is there something there that will make it materially different than that?

Wayne would probably always nod at some burn rate and cash, and I will always tell you we want to fund our CapEx with operating cash. And I'm looking at Nick and making sure he's nodding with me on that.

So, 2013 we could see free cash flow break even to positive?

That's always my target, and I think we could get there whether or not that's were our guidance ends up. I don't know.

Okay. Thanks very much, great quarter.

(Operator Instructions)

Howard Rubel with Jefferies.

Thank you very much. Dave, just to touch on a couple of operational things, what are you doing with headcount? On one hand, clearly business is growing, on the other hand there's some incremental uncertainties.

Well, we're going with demand. And the uncertainties that most of you are feeling with Spanish get and such just don't line up with our demand. We struggled a little last year to keep up with the demand. So we're -- we want to make sure we stay ahead of it because we get great leverage.

So, we add less people and our sales go up and that's why we're delivering these great leverage numbers. I think we're always conservative on it. It is extremely painful and incredibly expensive to have to take people out and retrain when they come back up again. So I think we're being prudent about it, but I'm not making a any apologies for the world's difficulties. We've got growth.

You're adding a little bit of overtime then in the process. I would guess.

We always end up with some overtime especially if we have frantic growth. So we've hade nine straight quarters of year-over-year orderly double-digit growth. And I say orderly, as opposed to frantic growth.

I'd go back to -- you were here, I'd go back to the first half of 2008, we had a 23% year-over-year growth rate for that half. It was 17% sequentially. The scramble to hire, excess set ups, overtime, premium shipments, resulted in a lousy 9% operating leverage on the growth. It's much easier to make productivity improvements and get good leverage when it's a steady trend in the teens as demonstrated in the last 12 months.

So, in just one last factoid, I was looking this morning the first half of 2008 with that frantic growth, we delivered the best operating income in the history of the Company. But we made more EBIT this quarter than that entire half, even though the sales were only at a 13% higher run rate. So orderly double-digit growth is a great way for us to expand our margins and see what Nick is made of.

No, that's exactly what you seem to be doing and you seem to have better I would call a touch points into the supply chain than you've ever had. Can you maybe elaborate a little bit on that?

Can you elaborate on the question?

Well, I mean you're always pushing back to make sure that there's not too much somewhere or that in fact you're managing the business for that --

So you're talking about our customers, right? Which -- the forward of the supply chain.

Yes.

We worked hard after the A380 fiasco in the early 2000s when there was so much inventory in there. We ended up figuring out a process to go touch every single user of the materials and try to keep an eye on how much they have in their pipeline going forward. So we have a better sense of what either shortage is or oversupply might be coming down the road. It helps us plan a little better, plan our staffing, plan our capital. So, thanks for noticing.

And then the last thing, and I'm going to notice this to, is that GE guys are very excited about what your product is going to do on the max or on the LEAP-X. And it looks like Boeing is more or less has defined what the max is going to be. How do you feel about your content today versus maybe12 months ago on both of those airplanes?

On the re-engines, planes?

Yes sir.

Well, I would live to tell you that it's way, way, way too early to talk about it. But we did, just to get people calibrated, put out sort of a target of a 50% increase per airplane on both of those programs last fall just because we had people guessing all over the map. I think that's a reasonable target. In fact, I think it's one we could beat. But again, there are lots and lots of decisions to be made on what the engine shares are. Who uses our acoustical treatment, what they do on the nacelles, who makes the nacelle, how much is composite, but it's all upside.

Thank you Dave, very much.

Michael Lew with Needham & Company.

Thanks and good morning.

Hello Mike.

A couple questions. With regard to the A350 program, when do you expect the secondary structural contracts to be awarded? Do you have a rough estimate on the aggregate amounts also?

We do, but we haven't elected to disclose yet. We just did the primary because of the magnitude of the CapEx.

We don't typically announce contract by contract. And in fact, in the case of EADS, we have a big contract with the entire Corporation and things are incorporated in that or not. So we aren't doing these piecemeal in the real world. So we have no announcements yet. I think in the not-too-distant future, maybe by the time the plane flies next summer, we'll give you a better number for what that content will be.

Okay, that's good to hear. On the industrial side, what was wind in the second quarter? How much did it comprise of industrials?

We don't break it out. It's more than half as usual, and we don't break it out just because we really have one competitor and just a couple of customers, so --.

Okay.

That's why we say we don't break out. It was very strong as a it has been for the last three or four quarters.

Right. And you mentioned one primary customer, but how many other customers are you supplying to? The ballpark number.

Well we are supplying to a number of customers and working on a number of programs. But materially, it's still a one customer game and that's how you ought to think about it.

Well when would some of these other customers potentially do you think they would come to -- become larger scale? Is it anything that you would say over the near-term?

Not sure of the definition of near-term.

Let's say over the next year.

I would say not too significantly. I think if we penetrate it will be on new blades, larger offshore blades or new spar designs, not existing production, existing tooling, training, expertise. The likelihood of those changing is not too significant. So, I think it would be more gradual but then could be significant if we are successful on a new blade that begins to sell.

Okay. And also lastly on the space and defense side, I guess your competitor recently mentioned slower demand related to the joint Strike Fighter program. From a modeling perspective, would that suppress growth in the back of the year for the SMB segment?

If that customer does use our carbon fiber we have other things that go on to the program and to the extent that customer slows down his orders to us, it would suppress it somewhat. I don't think you're going to see it though, because that $35 million is really just starting up and I don't even think it's yet in our top five. Is that right?

Yes.

Great, thank you.

(Operator Instructions)

Avinash Kant with DA Davidson.

I had just a quick question on the capacity side. Of course you've been building capacity and putting CapEx out. The question I had was that with 2012 and 2013 spending, which is expected to be kind of at a similar level, what kind of revenues do think you will be able to achieve? Or would you be basically done with the spending on most of the key programs that are inside at this point? Which it would be -- (multiple speakers)

I would think we have a couple more years of it to get the capacity in place for the growth that we currently see on the 787, the A350. So we haven't gotten specific about it, but I think I said in the last call, we probably have a couple more years at these high rates to get to where we need to be for a full run rate on both those programs.

So a couple of months, that means to 2014 you mean?

Right.

Okay. And also the defense side, I'm looking for the -- of course that you said [JSF] is not among the top five programs for you and there's been a lot of discussion about budget cuts and everything else in the [Texan] side and people are a little bit worried. Do you see any risk to some of the key programs that you have on the defense side for 2013?

We haven't given 2013 guidance yet, but as we've said before, we have a very broad range of products and a very broad range of programs and it's not just US. So, the helicopter blade programs that we have with almost every helicopter manufacturer are upside for us to be able to offset any slowdown. I haven't heard talk of outright sudden stop on programs in 2013. In fact, I think I just saw that UTC did a five year block extension on the Black Hawk helicopter, which is an important program for us.

We have the A400M transport in Europe, which has got an all composite wing as well as tail, is starting to have some successes and seems to be on a pretty good track. F35 may be slower than what was expected years ago, but incrementally, I still expect that F35 is going to continue to grow.

So as I've said before, I think we're going to still continue a single-digit growth pattern based on what I know now. Maybe worst-case we're flat. Quarter-by-quarter, it doesn't necessarily track with that, but the diversity of our applications and customers and secular penetration and forward penetration of helicopter blades gives us quite a bit of confidence that this is going to be a good market segment for us for some time to come.

Perfect. And then final question on the wind side, I think the previous question was trying to ask that something similarly, but you have seen the one key customer that you've been exposed to thus far. We've been hearing about one the major players actually trying to start or at least thinking about starting to use composites in the turbines. Would you think that another major customer is close to starting to adopt these materials in their design?

Well, they all use composites. Our technology that we put forward is pre-impregnated glass and pre-impregnated carbon fabrics or fibers.

The other process is a more direct process, where they buy the glass and they put in the mold and then they pump in the epoxy's. So they're two different technologies and Vestas and Gamesa have long believed that pre-preg is more highly engineered and better weight and balance control and that's how they design and build their turbines. And some are going to a pre-preg based spar which is the center structural part of a blade and that's probably where there would be penetration if we were to have some.

So you'd see other people adopting pre-preg based spars?

Yes on the very large blades there is a movement towards pre-preg, because of the loads that are required and the incredible weight addition there is for incremental length on a blade.

Perfect. Thank you so much.

Peter Cozzone with KeyBanc Capital Markets.

Good morning.

Hello Peter.

Just a couple quick questions, on the corporate and other expense line, is that adjusted kind of $13.7 million in 2Q a good quarterly run rate for the back half of the year?

Yes, that's close enough. The $13.7 million excludes -- I take it you excluded the environmental charge?

The environmental charge, correct.

Right, correct.

And then also, can you maybe just give us an update on where you are in regards to capacity expansion process? I know we're fairly early in the game here, and those won't be coming online for the next couple of years, but just give us an update there. And then have incremental cost roughly stabilized or are there any expectations or plans that might bring those up heading into 2013?

Well our game plan is to add the capacity in tranches or layers. That's how we mapped it out, that's how we expect it with in particular the A350 as the program goes down the path. The first flight, and certification everybody in the supply chain has expected to start increasing their build rates gradually, and it allows us to spread out our capacity increases and do it in blocks. So we are well into that.

We've done a couple of blocks, if I could just describe them generically, and the next block is underway. We had, the incremental costs that you referred to, do create a headwind. But to the extent we've got top line growth, we are able to cover it and in fact, even not have to complain about it.

So, last year in the second quarter we had some start up costs, second and third quarter and that's one of the reasons the leverage is good now. We will have some start up costs again late in the year or early next year. We already have started to hire for one of the next line that we're going to start up because it's a long training process.

But at the end of the day, we're committed to this leverage base over 20% and capable of doing more than that as we've demonstrated through the startups at we've already encountered. So I wouldn't worry too much about it.

Great, thank you very much.

David Strauss with UBS.

Good morning.

Hello David.

I apologize as I joined late if these have already been asked, but engineered products, the margins there, do you expect to still get back to the 15% to 16% level in the back half of the year? And then Wayne what do you estimate your average interest rate is now on your debt -- outstanding debt?

On the engineered products, it's a smaller part of the business and it's lumpy. We've got some new products and new programs that are in start up phase. I'm pretty happy actually with the performance that they've had in the first half. As those start to get up to stride, I would think we could easily get back to the 15%, 16% range by the end of the year. And Wayne?

Yes and with respect to the data, our average rate is a little under 3%.

And Wayne on depreciation, do still you still expect that to pick up in the second half of the year?

Yes, we do.

Okay, in the still $8 million or so higher for the full-year?

Yes, I think it will be tough for us to get $8 million higher for the full year. Some of it's just due to the translation, but we're probably a little bit behind in terms of adding and we've probably -- more items have fallen off that we thought. But we expect it to be higher in the second half.

Okay, thanks a lot.

It appears there are no further questions at this time. That concludes today's conference. Thank you for your participation.

Great, thanks.