Hexcel Corp (HXL) 2016 Q2 法說會逐字稿

Good day, and welcome to the Hexcel Corporation second quarter 2016 earnings conference call. Today's conference is being recorded. Hosting today's conference are Mr. Wayne Pensky, Chief Financial Officer; and Mr. Nick Stanage, Chairman, Chief Executive Officer and President. At this time, I would like to turn the conference over to Mr. Pensky. Please go ahead, sir.

All right, thanks. Good morning, everyone. Welcome to Hexcel Corporation's second quarter 2016 earnings conference call on July 21, 2016.

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 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 re-broadcast without our express permission. Your participation on this call constitutes your consent to that request. With me today are Nick Stanage, our Chairman, CEO, and President; and Michael Bacal, our Investor Relations Manager.

The purpose of this call is to review our second quarter 2016 results detailed in our press release issued yesterday. Now let me turn the call over to Nick.

Thanks, Wayne. Good morning, everyone, and thank you for joining us today. As you have seen in last night's release, we had a strong second quarter, with sales of $523 million, 10% above the second quarter 2015 sales in constant currency.

Our key growth programs remain on track and performed as expected. Our operations continue to perform well, delivering record second quarter operating income of $100 million, with a strong operating income margin of 19.2%. Our adjusted diluted EPS of $0.70 was a record quarter for us, and 11% higher than the second quarter of 2015.

For the first half of the year, revenues are up about 8% to $1.20 billion, as we are on pace to achieve our plan and exceed $2 billion in sales this year. Our adjusted diluted EPS for the first half is $1.29, or $0.08 better than last year's first half.

Now let me briefly provide more detail on our markets. As usual, I will discuss year-over-year comparisons in constant currency. As you are aware, currency movements influence our reported results, and some of this impact is not intuitive. But the bottom line is that when the dollar is strong, our sales translate lower while our income increases, and so our margin percentages improve.

Commercial aerospace now accounts for 70% of our total sales, and our second quarter sales increased 14.3% versus 2015. Total revenue from new Airbus and Boeing programs, which include the 787, A350, A320neo, and 737 MAX, increased more than 50% in the quarter, as compared to last year, driven by the A350. Airbus and Boeing sales for legacy programs declined slightly in the quarter as compared to Q2 2015, while legacy sales for the first half of 2016 were sequentially greater than the second half of 2015.

Sales to other commercial aerospace, which includes regional and business aircraft, were about 15% lower compared to last year's strong second quarter. However, sales for the first half of 2016 were about 10% higher than the second half of 2015.

Space and defense sales for the quarter were $82 million, down 7.6% as compared to the second quarter of last year, and in line with the run rate we saw in the second half of 2015. The quarter's sales decline was driven by rotorcraft, which make up just over half of space and defense sales. However, sales of both military and commercial rotorcraft were higher in Q2 than they have been in each of the last three trailing quarters.

As you recall, we went into 2016 expecting space and defense sales to be at the same level as 2015. Last quarter, we concluded it would be challenging to maintain our 2016 space and defense sales at those same levels, and that continues to be our view. We are on more than 100 programs, and our challenge for the full-year versus our original plan boils down to two areas.

First, we're expecting to see some customer supply-chain adjustments on the A400M. Second, we anticipate further reductions in helicopter programs both from lower spare blade orders and lower commercial helicopter demand. And this is at Sikorsky, Airbus and AugustaWestland. We're not changing our guidance on total sales, as we believe the other markets will offset any shortfall in the space and defense segment.

In industrial markets, sales for the quarter were $72 million, up more than 14% year-over-year. Wind energy sales were up mid-single digits for the quarter as compared to a year ago. The additional growth we saw in the quarter came from our recently announced Formax acquisition.

Now let me turn the call over to Wayne to discuss some of the quarter's financial details.

Thanks, Nick. For the quarter, gross margin was 28.8%, and for the first half of the year, gross margin was 28.7%. These strong results included that we executed the start-up of several new production lines for additional capacity to support our forecasted growth. Exchange rates did not impact the second quarter gross margin as compared to the second quarter of 2015.

For the quarter, selling, general, and administrative expenses of $39 million were just slightly higher than the second quarter of 2015. Research and technology expenses were $1.2 million higher than last year's second quarter, and for the first half of the year, these expenses are now just more than the first half of 2015. I would remind you that the timing of R&T spend can be lumpy.

For the quarter, operating income as a percentage of sales was 19.2%, as compared to 19% in 2015. Exchange rates contributed about 20 basis points to 2016's operating income percentage as compared to 2015.

Depreciation and amortization continued their planned ramp, with first half expenses more than $8 million higher than the 2015 period. Our engineered product segment delivered 12% operating income margin for the third quarter in a row, as compared to the 14% to 16% margins we had previously achieved over the prior few years.

We do experience a learning curve in this business as we start up new programs and replace mature legacy programs as they wind down. We will continue our focus to optimize our margins in this increasingly competitive segment, though a 12% margin still produces a very attractive return on invested capital.

The effective tax rate for the quarter was 30.5%, as compared to last year's second quarter rate of 30.6%. For year-to-date, the tax rate is 29.8%, as the first quarter of 2016 included a $1.2 million tax-related benefit from the early adoption of a new accounting standard regarding accounting for shared base payments. Excluding this discrete benefit, our first half effective tax rate was 30.5%, in line with our full-year guidance.

For the first half of the year, free cash flow was a use of $21 million compared to the use of $116 million in 2015. Cash provided by operating activities was $135 million compared to $50 million in the first half of 2015, as working capital usage was $63 million less than in the first half of 2015.

Our working capital has seasonal fluctuations; for example, in the first quarter, our working capital has a use of $91 million, while the second quarter was the source of $18 million. We expect working capital to be a modest source of cash in the second half of 2016.

Cash used for capital expenditures were $156 million in the first half of 2016, compared to $166 million in the 2015 period. We invested a total of $25 million in two companies this quarter. In both cases we are taking small positions in these companies.

While they are quite different opportunities, in each case they provide access to exciting new advanced composite technologies using our materials and provide for expanded research and technology collaboration in novel areas. We will continue to evaluate investments along these lines in the future and expect to be flexible and disciplined in acquiring and supporting a variety of market and technology enablers.

During the quarter, we repurchased $20 million of shares under our authorized share repurchase program, and we have $140 million remaining under this program.

In June, we announced that we had amended and extended our $700 million senior unsecured revolving credit facility. The maturity of the facility is extended from September 2019 to June 2021. The amendment also invites for modest reduction of interest costs as well as less restrictive covenants. Due to the refinancing, Hexcel accelerated certain unamortized financing costs of the old facility, thereby incurring a pre-tax charge of $400,000 this quarter.

At the end of June, we also entered into a EUR60 million, seven-year term loan. Borrowings on the term loan will start in the third quarter, and will be used to help fund our expansion plans in France.

Now let me turn it over to Nick for some final thoughts before we take your questions.

Thanks, Wayne. The strong first half of the year demonstrates we are executing on plan, and we are on track for another record year. The outlook for growth in our commercial aerospace market is very strong, thanks to our positions on new programs such as the A350, the A320neo and the 737 Max.

Accordingly, we have increased the mid-point of our earnings guidance and narrowed the range to $2.48 to $2.56 per share. We have also narrowed the range on the full-year sales guidance to $1.99 to $2.05 billion. We continue to expect free cash flow to be in the range of $20 million to $60 million after CapEx of $280 million to $320 million.

The first half of the year for commercial aerospace was a bit higher than we anticipated, and we expect commercial aerospace to end the year at the high end of our guidance, which will help offset any shortfall in space and defense sales. We're focused on maintaining alignment with our customers during the critical A350 ramp-up phase and the A320neo and 737 Max conversions, while also adding more responsiveness within our supply chain to allow for some short-term gains.

We will continue creating a solid foundation for EPS expansion going forward through our commitment to operational excellence and continuous improvement. And as we continually look to the future, we will maintain our relentless focus on investing in new technologies to maintain our leadership position to provide our customers with innovative solutions for next-generation products.

Rachel, we would now be happy to take questions.

(Operator Instructions)

We will take our first question from Myles Walton with Deutsche Bank.

Thanks. Good morning; good quarter.

Hoping you could touch on the growth of the new programs for a second. Greater than 50% growth year on year again, both in the quarter and the first half. You comment that the A350 led the growth. I just want to clarify -- is that A350 was growing more than 50%, or it was the biggest dollar contributor to growth?

It was the biggest dollar contributor to the growth. And certainly we saw growth in other platforms, probably next was the A320neo, and, to a smaller extent, the MAX, because it is further out.

Okay, good. On the defense side of the Business, it does look like maybe most of the pressure is coming through in the engineered products group. Is that the location of the A400M inventory stocking as well, or is that across both segments?

It is across both segments. I have to look, but I don't think the A400M impacts Kent at all, to speak of. But we are seeing some softness in the rotorcraft, which does affect Kent.

Okay. The other one -- so now that the XXX fiber source has been extended to Cytec/Mubadala, is there anything bigger, Nick, in terms of wins, either that you have that you can't speak about, or that you could win that would kind of divert or change the $1.1 billion CapEx budget you've talked about through 2019?

Specifically on the 777X, we have engine to sell, and just because Mubadala and Solvay announced their agreement, which was expected, do not assume that we are not continuing to work with Boeing on new technologies for both primary and secondary materials, which we are.

Having said that, we have good insight into probabilities, and it is a little early for us to go there yet, given that EIS is not for two or three more years on the 777X. But I would say the incremental gains we will get will have a minimal impact on our CapEx, as compared to what we provided when we gave our 2020 vision.

Okay. Great, that's it. Thanks.

Thanks, Myles.

Our next question is from Gautam Khanna with Cowen and Company.

Thanks, guys. I was wondering if you could talk a little bit about FX as we look into next year, how much of the year is hedged, and how much of a positive lift the pound's weakness might in fact be?

Yes, Gautam. In terms of going into next year, we don't give guidance, but at the end of the year we'll give a little bit more details. But generally speaking, when you are looking out 3 to 8 quarters from now, 3 to 6 quarters I guess it would be, we're probably in the 60% to 70% hedged ratio.

The pound exposure is roughly about $50 million worth; so at 10% movement for a full year is worth $5 million. So, the opportunity is the part that is unhedged, in terms of gaining (inaudible).

Got it, okay.

Just to be clear, for the second half of this year, the benefit's probably in the -- it's just a few hundred thousand dollars, because we are already fairly well hedged for this year.

Got it, thank you. I was wondering, Wayne, if you could also speak to what you anticipate incremental margins will be as we move through the next couple years with Formax?

The reason we don't talk about Formax for this year is because we are bringing their whole business, and just like us, they are not at a 25% margin for the whole company. So going forward, in terms on the incremental basis, we are not changing our target because of that -- because of them.

Okay, so, ongoing, in 2017 and beyond, you are still targeting mid-20%s?

Correct.

Okay. On the A400M and on the A380, could you talk about -- well, first on the A380, when do you anticipate you start to see a reduction in your demand, and the pull-through to you, for the first rate cut to 18 and then to 12? How does that phase in, and when do we start to see it?

As you would expect, we had anticipated that the rate was going to go down, because we have line of sight and very close communication with Airbus. Basically, for this year, we see minimal impact. Next year, certainly we will start to see the impact of the one per month, as we ship materials at least six months in advance for that.

(Multiple speakers) already at 18?

Correct.

And the A400M, what is the level of rate cut you are anticipating?

We are not thinking of a rate cut. What we are seeing this year is just some inventory. Our customers had too much inventory, and they are just getting back to levels they should be at.

It is more of they have over-ordered in the past and are catching up. This is not about rates.

Okay. Can you quantify what that impact is, in terms of sales?

Yes. (laughter) Whether we will is another matter.

When you look at the -- it's one of the big contributors to -- we went into the year thinking we were going to be stable, and we are going to not get that number, and that will be one of the big contributors to it.

So that explains the clip off the high end, maybe, of the sales range?

Right, correct.

Okay. Just last one, if you could give us any color on progress in the automotive composite space, if anything's changed in the past three months?

I don't know that there is any big awards that have changed. I would point out that certainly Formax has added capability and revenue into our automotive segment.

I would say we continue to work with key customers, including BMW and others, on new opportunities and platforms. So, we certainly are working the technology around snap cures and processing improvements and finding niche areas where we can differentiate. But in the scheme of things, it is still a very small number, and I don't see the mix or makeup of Hexcel changing any time soon.

Thanks a lot, guys.

You are welcome.

Our next question is from Howard Rubel with Jefferies.

Thank you very much. Nick, it sounds like everything is just like falling off a log, and it's easy to do; yet when I read Wayne's language in the Q concerning engineered products, it sounds as if there is a change in the pricing and in the challenges. Could you elaborate a little bit on how you can either improve that business going forward, or is this structurally the new levels of returns?

Well, for starters, Howard, you know me well enough that we are constantly pushing across the board on productivity and efficiency to improve our margins. Kent and our engineered product business is no different.

Now, we do have some things going on in Kent with respect to rotorcraft being down. And roughly 20%, in that range, of their business is rotorcraft; so the volume, obviously, has an impact to our overall operating income. And we have some legacy programs that have sunset, and we are bringing in new business; so there is a learning curve in the engineered products business.

Having said that, the cost to serve and the investment in this business is low compared to our composite business. So at 12%, although it's not where I want to be, I still like the business, and we like the opportunities we see to grow it.

But you haven't gotten a lot of tooling. At least we haven't seen any announcements about you getting any tooling business there, and that's been what I'd call another one of the hallmarks and qualities of that operation. What do you see in terms of potential there?

Well, you are not seeing us announce toolings, but I can tell you we've got multiple programs, very successful. It's pretty early with our HexMC and HexTool. We've had great success with CFAN, who use our composite tooling.

We continue to work very closely with Boeing, but, again, remember, Howard, tooling for the aerospace segment is very, very lumpy. There's always a very risk-averse approach, especially until composite tools make a real position and prove their way on the large tools, where Invar is prevalent today.

So the fact that we are not announcing any big tooling changes or awards, I'm still excited about that business. I think it will be lumpy, and I think it will be niche. Again, it's just a nice addition to our overall offering.

And, Howard, the new content on the nacelles for the neo and the MAX, a lot of that is in our engineered product segment.

That's very helpful.

Just two more questions -- one on cash flow. You articulated a little bit of improvement in working capital for the year. So are we talking maybe $40 million to $50 million from this level? I know sometimes year end can be weird, but can you quantify it a little bit?

Sure. Yes, I will agree that year end is weird.

If you look in terms of our target, our target is to be free cash flow positive by about $40 million for the full year, or minus $20 million going in, after the first half of the year. So we are expecting to generate about $60 million in the second half. That includes working capital, and generally speaking, should be a positive during that second half of the period.

Our receivables are clean, and that one's really moves with sales. And that's why you see the big fluctuations between how it winds down at year end and how it winds back up at the end of the first quarter. That's why we have such a big use in the first quarter.

I think there's one area where there is still opportunity is in the inquiries area. That's a lot of hard work, and we are clearly focused and pushing on, but that's probably the biggest challenge. But having said all that, we are comfortable with getting the $40 million of cash flow for the year.

I was just trying to get a range of what the language meant. It's pretty clear. I mean, I'm in the ballpark.

And then last, Nick, just to go back to these two M&A deals with Luminati and OPM. Can you elaborate a little bit more on the technology? I think the first is kind of a UAV-type opportunity, and does that mean there is open doors to a lot more UAV suppliers, and you want to try to pursue that in some fashion? And the other I know is a 3D approach.

When I looked at the price-to-sales that you theoretically paid for this, it's pretty large. Could you provide some market definition or color on the opportunities?

Absolutely. I will start with OPM, or Oxford Performance Materials. Just as a reminder, we acquired 10% interest, and given certain milestones we have an option of going up to 16% ownership. So they have developed a proprietary technology to produce PEKK thermoplastic carbon fiber reinforced 3D printed parts, and that's primarily for aerospace. And I'd also say they use our fiber. That's how we got close to them.

It's certainly a growing market. The applications are numerous. They have qualified their material already, and are working on multiple platforms where they have product flying.

We think this is a tremendous entree into this segment. We think we can take that technology and help lever our technology and increase our portfolio, and we are just excited about it. They are a small company, about 65 employees in Connecticut, but it was the right move for us.

On the Luminati, it's a little bit different. They are really new. They are not much more than a year old. Basically if you think about materials science experts working on light-weighting solar-powered aircraft.

And what they are doing is very applicable to the things we are trying to do both for military and commercial aerospace. That is, come up with technologies, with processes, to allow us to make our materials even lighter, more efficient, more cost-effective. It's a small investment, but it's very targeted to get some technology and to enhance our portfolio in an area that we see as a growing opportunity.

Thank you, gentlemen, very much.

Thank you, Howard.

Our next question is from Robert Spingarn from Credit Suisse.

Good morning. Could you talk a little bit about the movement in both the legacy large aircraft sales that you talked -- it sounds like there is just some volatility in that revenue line, up and down. And then as well, I want to ask about business in regional jet, which looks like it troughed in the second half of last year, but I am not sure that is correct. How do you think about that going forward, as new programs come online?

Okay, so I will start with legacy, and, Wayne, jump in here if I get off track.

A couple of things to point out -- number one, when we track legacy, as compared to new programs, it gets tricky on the derivatives. Specifically, the A320 classic moving to the neo -- some of the parts are identical, yet when they convert, we move them from what is classified as legacy over to new programs.

Same thing for the 737 MAX. It may look like legacy and that area is going down, when in fact it is not. As you know, the narrowbodies are both in the middle of ramp-ups with both Airbus and Boeing.

So the legacy, the real decline is coming from the widebodies. The 747 dropping from 12 to 6 starting in September, the 777 from 8.3 going down to 7. And the A330, which was at 10 a year ago dropped down to 6, and it is going to climb back up to 7 early in 2017.

And last, but not least, the recently announced A380 cut going down to 12 deliveries per year, where it had been closer to mid-20s, dropping to 18. And we are in the midst of that decline.

When do you think -- on those Boeing programs you mentioned, when do you think you get to the bottom there, especially on the 777s, since the throughput rate is really going to be below seven when you account for the blanks that go through. It's probably more like 5.5.

We try not to get ahead of Boeing, and we just try to stay very aligned, make sure we understand what they are building to, what the inventory and supply chain looks like, and what we are shipping to. We are very alert.

We're certainly keeping our eye on the 777, as well as the A330. Because these derivatives and the conversion are -- although they may be somewhat simple for us, for the rest of the supply chain and for Boeing and Airbus to make these, I suspect there is a fair amount of complexity in that conversion.

Have you thought about how much this is going to offset your growth on the new programs next year? In other words, what kind of drag you're going to have from these various declines?

Again, keep in mind we've got very good visibility with Boeing and Airbus, and obviously a lot of that is confidential. So a lot of what we are talking about here that is made public, we had insight into some of that. Very similar to next year -- we anticipate and make sure we stay very closely aligned, and we've done a pretty good job on our top-line forecasting year over year, being aligned with the OE rates.

And just on the BizJet and Regional?

On the BizJet and Regional, as I said, the first half of last year was unusually strong. The fact that we are higher than the second-half run rate gives us hope that we did hit bottom, and potentially we'll hold, if not grow, there.

Again, we always look at -- is there any individual program or area that is really driving the performance, and it's not. And just as a reminder, Gulfstream, Bombardier, and Embraer account for the majority of the sales in this segment.

Right. And then just high level, understanding all of that, when you think about cash flow conversion, and you've talked about some working capital improvement here in the second half, but longer term, as we look forward, when can you start to return to a more robust cash flow conversion? Is that 2017, is it 2018, when will we see that?

So, I guess the way I would answer that, given the opportunities we have in the composite space, given the opportunities for further secular penetration, I am optimistic that we are going to communicate more capital required because our growth is going to go higher. So I'm not really looking at getting to a steady state, ongoing business where we just have maintenance capital going forward. We are pushing hard on organic growth. And as you can see, it is flowing through, and I am anticipating that for the foreseeable future.

Okay. Thank you.

You are welcome.

Our next question comes from Chris Kapsch with BB&T Capital Markets.

Nick, just to follow up on the comments you just had regarding insights into some of these legacy programs, and as you laid out your longer-term forecast, actually I think you referred to it as a commitment more than a forecast or an aspiration. Presumably you had some insight into, say, the fading relevance of the A380 or 747, the inevitable transition from the 777 to the 777X, and maybe, as you alluded to, some of the other I guess rate reductions that are happening. So I'm just wondering, as you think about that long-term forecast that you laid out in Salt Lake City in early 2015, how is it now playing out relative to that commitment that you foresaw and conveyed to investors?

Basically, we still maintain our position. We continue to see things move up, move down. I mean, there is a lot of puts and takes. But overall, we feel comfortable with where we are, in sight of what we communicated back in Salt Lake City in early 2015.

Chris, if you think about it, all those things you mentioned happens between 2015 and 2020. So by the time you get to 2020 -- .

You are at a run rate.

You are at the run rate. So how we get from here to 2020 may be different, but once you are at 2020, the outlook hasn't changed much.

Got you. And if I could just, look at the gross margin improvement on sequential basis in the quarter, presumably some of that is related to just better utilization of recent product line capacity increases. Could you speak to how far along are you in ramping and qualifying those new production lines, and should we expect additional sequential improvement on the margin line as those are better utilized and more fully qualified?

I will take a shot at this. And just as a reminder -- we talked about this last quarter. Just as a recap, for the first half of the year we basically put in place one precursor line, one carbon fiber line, which are the most capital-intensive capacity we have. We also put in a resin mixing system.

We readied a second resin mixing system in the second quarter, and we put in place four prepreg lines. So that is all good news. That is all needed. All of that capacity is accounted for, but it does not come online fully utilized; as you can imagine, it tends to be a little lumpy.

As we go through time, I certainly would expect those lines to get filled and for our efficiency on those lines to improve. Having said that, through the course of the year, we do not have the capacity in place to fill all the demand that we have booked, so we are going to continue to invest and continue to spend, and you will see other incremental tranches of CapEx come online throughout the year and next year.

Okay. I appreciate that.

And then just one follow-up on the space and defense comments -- there is, out of Lockheed Martin, generally, bullish commentary about the key F-35 program transitioning beyond LRIP. Just wondering, you talk about some weakness related to A400M and rotorcraft obviously, but just wondering when you would anticipate seeing benefit from that key program? I think it is a top three program, and so I'm just wondering what the visibility is on benefit to the space and defense segment from that program. Thanks.

Yes, Chris, it is in our top three, and it probably has the most potential for growth going forward. And it is growing. It is probably growing, in 2016, a little less than what we initially thought in our plan, but we again stay very aligned with Lockheed and with our supply chain, and see that as a great opportunity going forward.

Okay, thanks, guys.

Thank you.

We will take our next question from Ronald Epstein from Bank of America.

(Technical difficulty) calling in for Ron. Nick and Wayne, regarding your sales target in 2017 of $2.5 billion, can you talk about maybe how much of that you have clear line of visibility to at this point today? And then also to give us an idea how much contingency you have in place should there be additional changes in production from the OEMs?

So, again, just as a reminder, and I had to go back and look, but when we communicated our 2017 view, it was in 2012. And I would remind you, if you look at foreign exchange rates in 2012 versus where they are today, it is a material difference. The line of sight to $2.5 billion in 2017 is no longer valid.

Having said that, space and defense is lower. Commercial is pretty much where we expected it in the range. But we really aren't looking at 2017 as much. We are really focused on 2020, and we will provide 2017 guidance in December, most likely, this year.

And then I guess with that as a follow-up, right, in 2012 you provided your 2017 outlook, and then in 2015 you provided your 2020 outlook. Should we think about your 2020 outlook that you gave in 2015 similar to now how we're seeing the 2017 outlook you provided in 2012?

I can't tell you how to look at it, but the way we look at it is the $3 billion still looks achievable. There are some headwinds, no question, but there are also wins that we continue to gain that will help offset that. So with respect to our top-line sales, cash flow, and especially our EPS, I feel very confident on the $4.50 per share that we communicated back in 2015.

Great. Thank you.

You are welcome.

We will take our next question from David Strauss with UBS.

Thanks. Most of my questions have been asked.

Wayne, you had talked about earlier cash taxes increasing $25 million to $30 million in 2016. Is that still where you are tracking?

David, we hope to do a little bit better than that. There's been a number of tax changes that should help us in terms of cash taxes, so we do expect to be a little bit better than that number.

Okay. SG&A as a percent of sales has come down pretty nicely now, 7%, 7.5%. How are you thinking about the margin improvement from here, gross margin versus SG&A improvement?

We are looking at each other. With respect to SG&A, that is something we take great pride in managing that well. We do have to add infrastructure and costs as we get larger, but on the other hand, we don't expect it to go up nearly the same level as sales. We do expect to continue to get leverage from that.

Yes, we drive volume leverage with the team. We talk about it all the time. As you know, we're investing in a couple of new sites that are in process, one in France, in Roussillon, and one in Morocco, to help us expand our positions and growth with customers. Overall, we are pushing to increase SG&A a fraction of what our top-line growth is.

Okay. And the last one, I don't think you have updated your share count assumptions since you gave it at the beginning of the year. I think it was 96 million shares. Can you tell us what you've got assumed in your guidance now?

It would be lower. (laughter)

Right. I got that.

We are at like 94.6 million, but generally speaking, David, our guidance we're expecting it to hold flat at his point, at that level. It might pick up a little. I would say for rounding purposes, I would use 95 million.

All right, thank you.

Thanks, David.

We will take our next question from Noah Poponak with Goldman Sachs.

Good morning, everyone.

Good morning, Noah.

Back to the new programs that are ramping in the large commercial aerospace sector, some others in the supply chain that are also relatively long-lead suppliers have reported that the consternation in the ramp-up, some of those programs, has disrupted their business and their results and outlook this year. You are not reporting that, and actually reporting that you are ahead of your plan.

Can you maybe speak to why or how that could be different between you and others in the chain? And then also how much risk is there that eventually what is happening specifically with A350 and A320 being slower than one would have thought, the risk that eventually does impact you?

I will take a shot, Wayne. Again, if you look at the supply chain that we ship to, Noah, you mentioned we ship in advance, and on average we calculate it roughly six months. Some areas it is further out, and some areas it is shorter.

A350 alone, we have 45 plus ship-to's, and there is no question within the supply chain that there are some suppliers that are probably ahead of schedule, some that are behind, and some that are right on. What we do across the board is we make sure we understand what is going on in the OE's plant, what their build rate is; we do sanity checks to check how are we shipping against that.

Obviously there is some noise in the supply chain that maybe we don't have total visibility to. But as of today, we feel very comfortable with our alignment with commercial aircraft legacy, narrowbody. And again, the one area where we do see some potential contraction is the A400M. But we feel pretty good about the commercial aero.

So is the answer there that you perhaps have better systems, processes, checks on where you are delivering versus where the OEM is?

Again, I have said this before for certainly our composite and prepreg material, it has to be frozen. So it goes from our freezers into our customer freezers or the supply chain freezers. I would say we have pretty good visibility with that.

I am not going to say we are better than the other supply chain. I can only speak to where we are, and we have maintained adequate supply, given that we are sole source on many of these products. And we've maintained very good alignment.

Wayne?

The only thing I was going to add, Noah, is perhaps some of the consternation you are referring to is that there is a big difference right now between the production rates and how many they are actually delivering.

Yes.

If you are in that last part of that chain, you probably have more volatility than we would.

Right.

And obviously, the risk everyone is worried about is that at some point if they don't catch up on deliveries, they might -- I wouldn't say slow down the production rate, but probably not ramp it up as fast as we would like, and so that is probably the risk.

Okay. Can you tell us specifically what you are building to per month on A350 right now?

We are around seven.

Okay. And 787, I guess maybe at this point sort of lingers between new and legacy, and kind of moved out of your list and mentions of new. Maybe if you could tell us what that program did for you in the first half in terms of a growth rate, and what are you planning for next on 787?

While Wayne is looking for the number, I can tell you that Boeing is in the process of ramping up to 12 per month, starting in April of this year. We're certainly at that level, and then going to 14 in 2018, which is a little early.

And we are consistent with those rates. The only thing I would add, at some point we have to stop talking about legacy and new programs, because, as you and Nick talked about earlier, using narrowbodies as they go from classics to the new engines, it's getting to be more complex to keep track of it, almost misleading. So at some point we will give that up.

So you are planning to go to 14 a month in 2018 on the 787?

I think it was 2019.

Okay.

I don't remember off the top of my head.

I think Boeing has just said late in the decade.

Yes. That's correct.

Have you actually put any wheels in motion in your system to actually do that?

So we don't have to add specific capacity for that just yet, so the reality is we haven't had to do anything CapEx-wise, if that's what you are referring.

Another good point on this, just to remind everyone that our carbon fiber, our prepreg assets, are fungible. For example, that A380 volume that will ramp down, we'll consume that with other needed volume on growth programs.

So I guess, how likely do you think it is that Boeing goes to 14 a month on the 787?

You can ask them next week at their call.

They are the only ones that can really answer that. We are ready and capable when it is required.

Okay. Thank you for the time.

Thanks, Noah.

Our next question comes from Mike Sison with KeyBanc.

Hey, guys. Nice quarter.

Thanks, Mike.

Nick, when you think about -- I continue to hear that folks would be worried about peaking orders and aerospace cycle and stuff, and maybe highlight why you think Hexcel can continue to grow in an environment where orders are peaking and maybe some of the legacy stuff. Just kind of a general -- what drives Hexcel here through the next couple of years?

Well, I will start with the backlog. And just looking at the sheer volume of the backlog, even if it is overstated by -- pick a number, 10% or 20% -- it is still years and years. But really what I would focus on, Mike, is composites, the technology, the secular penetration opportunity on new aircrafts or derivative wings for next new airplanes or engines and nacelles.

If you look at the weight advantage, if you look at the life advantage and the overall life cycle cost, especially now, we're getting more productive. The efficiencies are getting better. Our customers are getting more efficient with it.

I just look at this as a great opportunity to continue to grow, and position our materials and products going forward. We clearly look at build rates, we clearly make sure we stay aligned, but I feel pretty good given the backlog, and given the air passenger traffic and the projections I see going forward.

Great. In industrial, you said wind was pretty solid for the quarter. You expect that business to continue to hold up as you go into the rest of the year?

Actually, wind, we came into the year thinking it would be stable, and it was actually up mid-single digits. And we feel good about it for the year. We think it will finish up a little bit.

Okay, great. Last one -- in space and defense, has the JSF started to perk up for you guys?

The JSF is growing -- maybe not to the level we put in the original plan, but it is a great program for us. It's in the top three, and we're certainly following Lockheed and looking at build rates, because we want to make sure we stay aligned with that program as well.

Great. Thank you.

Thanks, Mike.

Our next question comes from Richard Safran with Buckingham Research.

Nick, Wayne, Michael, good morning.

Nick, I wanted to follow up on your comments about the A350, the comments you also made about visibility with Airbus and line of sight. At Farnborough, Airbus was making note of the fact they were still having problems getting lavatories for the A350. It seemed to be they were a little bit concerned about what that would do to the rate ramp next year.

I am gathering from your comments, Airbus is not expressing any concerns to you about the A350, [either rate 10 in 2018] or the rate ramp next year. Is that a fair read of what you said?

It is absolutely fair. Keep in mind, they provided data that, end of 2015 they'll be at five per month, and in 2018 they will be 10 per month, and they have stuck to that. They may make some tweaks in between that, based on supplier capacity and making sure they manage the risk, but we are right in the middle there and not hearing anything different.

Okay. And then on your comments about the impact of the A380, okay, got you. With the rate changes, the rate down on the 777, the [747] that you mentioned a while ago on the 330 and the A380 -- when you have a change in rate down, is there any adjustment made to your pricing?

Typically not.

Okay. And then, finally here, I had a long-term strategic question for you. There was a lot of talk at the air show about a new airplane. And I thought maybe you would talk about technology trends going forward.

For example, do you think -- and I know Boeing has not announced anything, and I know we are just talking generally, but, for example, do you think a new airplane could be 50% composite? Do you think, for example, the next generation of composites might not use autoclaves, that sort of thing?

Well, I think all of those things you mentioned are potential, and I can tell you we are working on multiple technical solutions out of autoclave, in various product forms, in anticipation that different customers may choose different approaches. So we are working with Airbus and Boeing, just like we are with Safran and GE and a host of others on the next technology.

I think at the end of the day, the market is focused on performance, mechanical performance, and processing, and overall cost. And we are aligned with them and trying to make sure we can position our next generation materials to be the leader, as they are today.

Thanks very much. Appreciate it.

Thank you, Richard

Our next question comes from Ken Herbert with Canaccord.

Just first wanted to ask on the 777, as you look to the migration or the evolution of the 777X, are you still looking at content step-up opportunity equivalent to what you saw on the re-engined narrowbodies, especially when you factor in the nacelles and the engines and the upside there?

Well, we have never really set a target on what our growth would be on the 777X. On the legacy model, we are at $1 million per ship set, just slightly over $1 million.

There is no doubt in my mind we will exceed that on the new platforms, and I would tell you we are still working on multiple applications that I think have meaningful contribution. Now, whether or not we can approach a 50% increase, that is probably on the high end, but I can tell you we are working engines, nacelles, as well as structures.

Okay, that's helpful. Is there a time frame? This seems to have pushed to the right a bit. But a time frame when you might have more visibility or be able to speak a little bit more concretely about what you've ultimately captured on this program?

It is hard to give you bits and pieces, because I like to get the market to stabilize like it did on the A320neo. Once it went into production, and we pretty much knew what we were going to have, and we achieved the $450,000 per ship set, which was 50% incremental increase over the legacy, then we talk about it. Clearly, there are certain awards that we have already won on the 777X, but there is just too much that is still being worked for us to declare where our end ship set is going to land.

Okay.

And really you have to think about it, next year, the end of the year next year, the 330neo will enter service. We are still working multiple opportunities on that. The 777 is even further out than that. It is 2019, 2020 time frame. It's not going to be anytime soon that we will be able to say, okay, here is our ship set content on the 777X.

That's helpful. Just to follow up, one final question on a few of the earlier questions. Clearly, a lot of opportunity with any clean sheet plane out there, clearly it looks like the recurring cost of composite manufacturing, still sort of 2 times on the metal side, but there is a lot of technologies and everything you are looking at. Expectations of pretty significant improvement coming when you look at lay-down rates and other metrics that you are following.

Is there a certain number, Nick, that you think you need to get to, to maybe significantly open up more doors on a new narrowbody for you in terms of potential? Or how do you think about the evolution? I know it is obviously a long-term opportunity, and I know you are pushing in multiple directions, but how should we think about the potential opportunity opening up on these new aircraft with what you are pursuing?

I think, to start with the 2 times number that you mentioned as an acquisition cost on base material, and it really does not look at life cycle cost. Where you take advantage of the improved inspection intervals, and the life expectancy, and on and on with respect to the infinite life on composites.

So I think one of the areas we are focused on, and it has been talked about before, and that is the narrowbody fuselage; that is an area where we have to come up with some innovative solutions to position composites to compete in that segment. I think the wings in the widebodies, there is my perspective that they will continue to be 50%, and an opportunity for even further secular penetration, and we have heard that from our customers.

Thank you very much for the color.

Thank you, Ken.

That is all the time we have for questions today. This concludes today's conference, and thank you for your participation. You may now disconnect.