Hexcel Corp (HXL) 2016 Q4 法說會逐字稿

Good day everyone, and welcome to today's Hexcel Corporation 2016 fourth quarter and full year earnings conference call. As a reminder, 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 call over to Mr. Pensky. Please go ahead, sir.

Great, thanks. Good morning everyone, welcome to Hexcel Corporation's fourth quarter 2016 earnings conference call on January 26, 2017. 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, and 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 that cannot be recorded or rebroadcast without our expressed 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 the call is to review our fourth-quarter and full year 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 fourth quarter with sales of $484 million, 4.6% above our fourth quarter 2015 sales in constant currency. Our key growth programs remain on track, and performed as expected. Our operations continued to perform well, delivering strong fourth quarter operating income of $87 million, with a healthy operating income margin of 18%. Our adjusted diluted EPS of $0.64 provided a strong end to 2016, which was yet another record year for Hexcel.

For full year, 2016 revenues were $2 billion, a landmark for the Company, as sales were up 7.9% above 2015 in constant currency. Our adjusted diluted EPS for the year was $2.58, 11.2% above 2015. Full year free cash flow was $73 million, exceeding our initial guidance range of $20 million to $60 million. In fact, our cash from operating activities was more than $400 million, by far our highest in history.

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 recorded results, and some of this impact is not intuitive. But the bottom line, is that when the dollar strengthens against the Euro and British pound, our sales translate lower, while our income increases resulting in higher margin percentages. Commercial aerospace now accounts for 71% of our total sales, and for the quarter these sales increase 7.6% versus 2015. Total revenue from new Airbus and Boeing programs, which include the 787, A350, A320 Neo, and 737 MAX, increased nearly 40% in the quarter as compared to last year, driven by the A350 and the new Narrow bodies.

For the full year, commercial Aerospace sales were 11.3% higher than 2015, with new program sales increasing more than 40%. Airbus and Boeing sales for legacy programs declined year-over-year by 8%. As mentioned during last quarter's earning call, we are going to stop calling out new programs and legacy program sales going forward, as the transition from legacy platforms to derivatives and new programs make this distinction no longer practical or meaningful. Sales to other commercial aerospace, which includes regional and business aircraft, were just above last year's fourth quarter, and slightly lower for the full year comparison.

Space and defense sales for the quarter were $79 million, down 4.2% as compared to the fourth quarter of last year. For the full year, 2016 sales were 4.6% lower than 2015. The decline for both the quarter and the year is driven by reduced Rotorcraft sales. Rotorcraft now accounts for more than 50% of space and defense sales, with more than 85% coming from military sales, as commercial Rotorcraft sales have declined in recent years. As you recall, we went into 2016 expecting space and defense sales to hold at the same level as 2015. We identified fairly early in 2016 that this was going to be challenging, and from that point the year unfolded as expected. The difference boiled down to two key areas. First we saw some customer supply chain adjustments on the A400 M, and second was the further reductions in helicopter programs from both lower blade orders and commercial helicopter demand, and was at Sikorsky, Airbus, and Augusta Westland. As a reminder we have a diverse and broad range of products in more than 100 programs in the US, Europe, and Asia, including Rotorcraft, transport, fixed wing, and satellite programs.

In industrial markets sales for the fourth quarter were $54 million, which was comparable with the fourth quarter of 2015. Wind energy sales were about 10% lower as compared to Q4 2015. For the full year our industrial sales were 7.4% above 2015, with wind energy sales at the same level as 2015. The rest of the growth we saw in the year came from our acquisition of Formax, which was partially offset by lower recreation and other industrial sub markets. Now let me turn the call over to Wayne to discuss some of the quarter's financial details.

Thanks Nick. For quarter, gross margin was a strong 28% as compared to 27.5% in Q4 2015. The full year gross margin was 28.2% compared to 28.6%, as all periods reflect strong operating performance. 2016 witnessed the start-up of several new production lines during the year for district capacity to support our forecasted growth. Accordingly depreciation and amortization continued their planned ramp, coming in $18 million higher for the full year than 2015 on a constant currency basis. Exchange rates had a nominal favorable impact on the fourth quarter gross margin, as compared to the fourth quarter of 2015.

For the quarter, SG&A expenses of $36.5 million were 2% higher than the fourth quarter of 2015. For the full year SG&A expenses were $158 million, just 1% higher than 2015. Research and technology expenses were $1 million higher than last year's fourth quarter, and for the full year R&T expense of $47 million were more than 10% higher in constant currency compared to 2015, as we continued to invest in innovation to support new technologies, products, and process developments. For the quarter our operating income as a percentage of sales was 18%, as compared to 17.5% in 2015. Adjusted operating income for the full year was $360 million, 18% of sales, as compared to 17.9% of sales in 2015. For the full year exchange rates contributed about 40 basis points to 2016 top rating percentages as compared to 2015.

Our engineered product segment delivered 14% operating income margin for the quarter, and ended the year with a 12.7% operating income margin, compared to the 13.6% margin in 2015. We do experience a learning curve in this business as we start up new programs, and replace material legacy programs as they wind down. We'll continue to work to optimize our margins in this increasingly competitive segment, though at 12% margins still produces a very attractive return on invested capital.

Effective tax rate for the fourth quarter was 27.9%, reflecting end of year adjustments to the full year effective tax rate, relating to the final income mix by country , and lowered deferred tax liability as a result of reduced future tax rates in certain countries. The lower effective rate contributed $0.02 to our fourth quarter earnings per share as compared to our expected 30.5%. For the full year, lower taxes helped our adjusted EPS by $0.06, as compared to our initial guidance. Excluding discrete items, the underlying effective tax rates in 2016 and 2015 were 30% and 30.9% respectively. We generated $73 million of free cash flow in 2016, compared to the use of $4 million of cash in 2015. This result was driven by higher earnings and lower usage of working capital, partially offset by an increase in capital expenditures in 2016 to $328 million, compared to the $305 million in 2015. We have targeted to maintain our return on invested capital above 14% during the CapEx ramp up, and pleased to say that our return on invested capital for 2016 was 14.4%.

For our free cash flow and increased borrowings during the year, we spent $191 million. This included repurchase of $111 million of shares under our authorized share repurchase program, $40 million on dividends, and $30 million on investments and companies. Reminder, we bought the remaining 50% of Formax last January, and then we made three investments in innovative companies that had promising technologies. We have $93 million remaining under our authorized share program. Now let me turn it over Nick for some final thoughts before we take your questions.

Thanks Wayne. 2016 was another record year for Hexcel demonstrating that we continue to execute on plan. The outlook for growth in our commercial aerospace market remains strong, thanks to our positions on new programs, such as the A350, the A320 Neo, and the 737 MAX. We recently provided guidance for 2017 and beyond, and continue to have very high confidence in our positive outlook for the Company. Our guidance for 2017 is an EPS range of $2.64 to $2.76, based on sales in the range of $2.05 billion to $2.15 billion, we are also projecting free cash flow for 2017 of more than $100 million. Thanks, and we would now be happy to take your questions.

Thank you. (Operator Instructions). We'll go first to Myles Walton. Go ahead.

Thanks and good morning.

Good morning.

I have a question for you on cash, if we could start there. So $400 million of operating cash flow is pretty great. The guidance for 2017 is also right around $400 million with lower CapEx dropping through. The question is, in terms of working capital counts, inventories, first time in a while where you had a source of cash, is that going to the level of trend, and given the cash performance you saw at $400 million, is the $400 million guidance for 2017 now looking maybe a little conservative?

Myles let me give you a few that might help a little bit. We are expecting an increase in cash taxes in 2017. We actually did quite well in 2016, and some of that got pushed out, and that's the way that we stand now, it reduces our cash by about $30 million. With respect to inventories, we did well in 2016. If you go back to 2015 we probably carried a little bit more inventories than we had liked, partly as we went through the new ERP implementation, amongst other things. We have been able to get it down. As we look out going forward, we probably always carry a little bit more inventory than perhaps we like, but our first priority has been to meet customer commitments. I doubt if we can improve that, but we'll still try.

Okay. And then maybe at a higher level, the underlying pull that you're seeing from your customers in the commercial side. I imagine the 350 from what Airbus was talking about, is still consistent with your plan. I am just curious on some of the other wide bodies where there have been pushes and pulls, or mostly pushes in the production rates lower in the mature programs, are you sensing or seeing any destocking negatively, versus what you would otherwise expect given the production right now?

Yes, Myles. Let me start with the 350. We ended the year 2016 running at about 7 per month. And as you know Airbus has communicated they're going to be at 10 per month by the end of 2018. We remain on track there, and see steady increases throughout the year projected for this year. The one item that stands out a little bit was the late announcement that Boeing made on the 777. We had anticipated the reduction in the rate, they in essence pulled it in a little quicker than we expected. We're going through that, we also expect a little supply chain tightening on that program, so we see a headwind on that program probably in the neighborhood of $15 million, maybe $18 million. Other than that we had anticipated pretty much all of the current wide body reductions that have been talked about, and supply chain adjustments that have been talked about.

Okay. Got it. Thanks guys.

Thank you.

Gautam Khanna of Cowen and Company has our next question.

Thanks. Good morning.

Good morning.

Wanted to get your sense of the cadence through the year of earnings, and if you could remind us of what we should expect seasonally, and given your comments on the 777, and some of the other rate perturbations, how that seasonality might be impacted by these changes? Any sort of color on earnings progression?

In general we give annual guidance, not quarter by quarter guidance. Just a few points. Remember just mechanically, how we record stock compensation expense, it is higher in the first quarter than the other quarters. Generally all things being equal, you'll see the first quarter about $0.06 lower than the other quarters. In addition second quarter usually tends to all things to, all things being equal be a little bit higher than the other quarters. You see in the third quarter, you have got summer, and you are up in the fourth quarter, you have always got year end noise, and so we tend to have a little bit higher first half than second half, all things being equal. But other than that, nothing we can point out at the moment.

Okay. That's helpful. And then, within industrial I remember you guided wind down a little bit at the December update. What's the latest here for that, what do you think happens to that business given all of the discussion on the PTC? Are we going to see declines for a couple of years, or how does this actually play out in the marketplace?

So, as you mentioned, we do see 2017 being a little softer for us. Specifically because of blade changeovers and mix. Given the positions we're on, we fully expect a rebound in 2018, and even above 2016 levels. So we still, from what we see, feel good about wind, and the efficiency that the blades and new turbines are generating, and their ability to compete with other energy sources. Now what the new political landscape might bring, we continue to monitor that. Obviously there's a lot of things being talked about globally. I can tell you we're doing pretty significant scenario planning across the board, on what could happen, what could influence headwind , what could offer tail wind, with respect to business opportunities, import/export, or tax. We're just monitoring it real time and maintaining our flexibility so that we can adjust and take advantage.

Just remember, Americas is maybe a fourth of our wind business.

All right. Thank you. One last one just on the M&A pipeline. What types of things are you looking to add, and if you have any sense for what are the, are there any big assets out there that could actually really help the portfolio, or are these going to be more tuck-in acquisitions as we've seen with Formax?

What you've seen us do with respect to Formax, and strategic investments in OPM and Luminati, and recently in December with Carbon Conversions, are going to be similar going forward. We're really aligning with our strategic plan, and that is to enhance our core advanced composite material position with technologies that allow us to offer our customers, more innovation, broader system or maybe vertical integration of our existing space. So I don't expect anything massive, but we have an active pipeline.

Thanks a lot, guys.

Thank you.

Up next from KeyBanc we'll hear from Mike Sison.

Hey, guys. Nice end of the year.

Thanks, Mike.

I want to understand the A350 a little bit. When you think about the growth for you, you should see good growth in the first half of 2017. But then in the second half of 2017, does that growth rate kind of flatten out, and then when Airbus ramps up to 10, is that more of a first half of 2018 impact on you?

So, first off, we remain excited certainly with the performance of Airbus on the program and very excited to see that they delivered pretty much on their plan, or at 49 A350s last year, and would expect that ramp to continue. Having said that, Mike, we ended the year at 7. We're going to increase steadily through the year and it's really not our position to give any more definitive guidelines on the specific rates that we expect Airbus to be. But it will be a gradual ramp between now and the end of 2018 to hit the 10, and we feel good about that.

Great. On space and defense, when you think about all the moving parts, do you feel it's bottomed to some degree. Does sound like the new administration wants to increase whatever military strength in the US here. When you talk to your customers, is that a positive potentially, as you think about through the end of the decade?

I certainly see it, we see it as a positive potential. And if you look at the programs we're on and the platforms we're on, and the continued secular penetration with things like the JSF bound to grow as you know, 2016 was relatively flat, as Lockheed didn't get out the number of planes they intended. A great platform for us which will be our biggest program. We track commercial Rotorcraft in that segment, I sure hope we're close to the trough. I've seen indications and others in the industry have said that they think maybe we are. Having said that, I don't see a big rebound in 2017, but down the road I think it will be a tail wind. And then again, just the new positions we have on programs like the CH53-K, the continued strength on the A400 M, and the V22, we still feel good, and are staying with our 3% to 5% long-term growth in this segment.

Thank you.

Thanks, Mike.

(Operator Instructions). We'll go next to Robert Stallard of Vertical Research. Please go ahead.

Good morning.

Good morning.

Wayne, I got a quick question for you. First of all, on the CapEx, how do you see the additions capacity tracking over the course of the year. When do you expect the Moroccan facility to come online?

So, Morocco, I'm just drawing a blank. Well, we're there. We're going to do a Grand Opening mid year, and we're actually producing out of a temporary location as we speak.

Okay. Normally on the new capacity that you are putting in place, what sort of utilization are you expecting in these facilities as you go through this year, and maybe into next year as well?

Some of this you go through the process we have to get the lines qualified. And so what happens during the course of the qualification, is you either expect that the products you make while you're waiting to be qualified will be qualified, and therefore you build up inventory a little bit, where you run them at a slightly lower rate. Particularly on the carbon fiber lines, and remember, the carbon fiber line in France will also start up this year. We will try to run them 24/7 as much as we can. But in terms of how they ramp during the year, our CapEx spend is probably a little more front end loaded this year, in terms of the first half of the year as opposed to the second half.

Okay. As a related issue, yesterday Boeing was talking again about moving the 787 up to 14 a month. How does your capacity look relative to that potential rate, and if they do pull the trigger, how much lead time do you need?

First of all, they're talking about end of the decade, if I read it right. So we'll have plenty of warning. We don't have that much in terms of our own carbon fiber on a lot of those programs. There are some particularly in the engines, but I suspect we'll get plenty of warning shot.

Thank you.

We'll go next to Ken Herbert of Canaccord. Please go ahead.

Good morning.

Good morning, Ken.

Hi, Nick. I just wanted to follow up from the Investor Day, one of the comments you made was it sounds like you're seeing a significant step-up in sales from 2017 to 2018. I think you mentioned double digit growth. Looks like with the A350, you're probably ending maybe this year at who knows, 8-ish, 9-ish a month, on your way to 10. Is it fair to say commercial aerospace from 2017 to 2018, it's really about the Max, and the Neo, and the narrow body ramp, that drives much of that upside, or anymore detail to bridge that 2017 to 2018? I know we're getting ahead of ourselves a little bit. But I think there is still a fair amount of uncertainty around that step up, as you sort of see an acceleration in sales coming out of 2017?

I think you hit the big ones Ken. It's the narrow bodies for sure. The Neo and the Max, but the A350 will contribute big as well in 2018, as well as 2017. Those are the key drivers, and then we have lots of other small movers that help drive the growth as well.

So 787 theoretically end of decade you may have started to see the part of that from 12 to 14, and that really wasn't part of your acceleration into 2018 assumptions then?

That's absolutely correct.

That's right. If that pulled in given our ship time, that could be a little tail wind towards the end of the year.

Actually when we gave the 2020 guidance we have said the assumption was 12 787's per month.

That's great. And then this year for 2017, I just wanted to circle back once more on space and defense. I mean last year a little weaker certainly than the initial expectations. I think sentiment is clearly looking that it could be a little better this year. I know obviously military Rotorcraft. Can you give a little more detail on the growth you're seeing in 2017 on some of the major programs, specifically the 400 M, and the V22, and the Blackhawk?

Well, we typically don't get specific on the programs. Again, given that we're on 100 programs, given the fact that historically it's been very lumpy with respect to order patterns, and how those orders flow through based on budgeting. So again, we see puts and takes. JSF certainly is one of the high points. But other than that, I don't want to get into what's going to go down a little bit, and what's going to go up a little bit. It's really mix and timing.

Okay. That's fair. I appreciate it. Thank you.

Thanks, Ken.

Moving on to Jefferies we'll hear from Greg Konrad.

Good morning.

Good morning.

Just wanted to touch on engineered products and you talked about it a little bit at the beginning of the call. You had a really good margin in the quarter. You mentioned there are a lot of programs that are early on in the learning. What type of margins do you think you can earn in that as some of these programs progress?

Higher is better, and we're always pushing, but anywhere in the 12 to 14, this business used to even run higher than that. Given the landscape, given the competitiveness, we feel real good in that range. But I'm never going to say I'm going to settle for 12. We're always going to push to maximize and streamline our operations. So the other thing I'd say is, we target the type of product we go after. Higher value, more complex, which justify a higher margin than say a very simple standard build to print product. That's what we look for in that business.

Just on the share count, I think expectation is to keep that flat year-over-year. Is that somewhat determining what acquisitions materialized throughout the year, and if that pipeline doesn't fill up would we expect to see share count down year-over-year?

Yes, so, Greg, let me give a more complicated answer. We ended the year with a debt to EBITDA ratio of about 1.5 times, and we have said we wanted to hold it at that level, and probably slightly increase it, and the goal is to maintain under 2.5 times, but as our earnings grow, we are going to end up increasing our debt. We have said for 2017 we will increase our debt. So the question is, what are we going to do with those proceeds. Our first priorities are always to fund the organic growth of the business, which we can do on our own, and second is M&A, which you can't control. So the third by default is return it to shareholders. Depending on how much we borrow, and depending on how some other things happen, we will then buy back stock at some rate. So we'll have to see how that develops. But if that happens then our share count would obviously go down.

Thank you.

Up next, from Bank of America Merrill Lynch we'll go to Ron Epstein.

Thanks. Good morning guys. Couple of bigger picture questions for you. Are you guys doing any advanced work on different technologies like things like cold cure, that could potentially be applied to a future generation narrow body, or something as such?

So, I can tell you we have a large focus on new technologies, new innovations, disruptive type technologies, not only on the raw material science but on the processing. As you know, these cycles are very long, and today we're working on aircraft that in all probability will not get launched and/or have any meaningful production until the end of the next decade, or even later. So we're not going to get specific on the technologies, but I can say some of our external investments that we have made that have been visible, some of the collaborations we're doing, some of the university work we're doing, and obviously our growing our R&T team here, here are focused heavily on advanced technologies and the composite material space.

Okay. And then maybe another big picture question if I may. When 787s first started rolling off the line, essentially the fly to buy weight aren't carbon fiber, the OEs were buying a lot more fiber than they needed ultimately. Have they gotten more efficient at how they're using fiber?

Absolutely. The industry, which is what you expect and what we need, is becoming much more efficient, and that opens up the entitlement, and the potential to increase the amount of carbon contact by plane. So, scrap and usage has come down. But that's just the benefit of the composite, makes it more competitive and allows for even more growth going forward.

Okay. Okay. Interesting. And then would you expect, I guess when I was looking at, we saw 787 all carbon fiber, A350 all carbon fiber. Then 777X came bumping along, and carbon fiber weighing in, not carbon fiber fuselage. Do you think that's setting up a new model going forward, or was that a simple because this is a derivative of a bigger airplane, they are just not--, do you know what I mean? I'm not articulating this well. Is the formula going forward carbon fiber wings with aluminum tubes, or is that specific to that airplane?

I think both Airbus and Boeing communicated not that long ago they were going to focus on derivatives for a time period, and no clean sheet design, and the fact that you have got some derivatives with the Neos coming out, and the 777X is not an all-new airplane, is simply what drove the change there. They stayed with the aluminum fuselage, they put the wing on. There is no question the big benefit with respect to the amount of content, the amount of weight is biggest in the wing. Having said that, the next new airplane, I think will be heavily dominated by carbon fiber composite. The next new narrow body, the question is will the tube be aluminum or composite, and that's the challenge we have to win that position.

Okay. Great. Thank you very much.

Thank you.

From UBS we'll hear from David Strauss.

Thanks. Good morning.

Good morning, David.

Wayne, a question for you potential tax reform and all of the things that are floating around out there, how are you thinking about looking most so color of quarter adjustment tax?

I got to decide whether I want to give my personal views, or Hexcel's views. Just to help set the stage, our US income is now a little bit less than half of our total worldwide income. So when we talk about US tax rates, it's a little bit less than half. The complexity of our US tax code and to multiply that by the complexity of the US tax accounting, makes taxes unbelievably complex. And I think for us mostly if you can simply that and always lower the rates obviously that's a good thing, but it always just depends on what's in the base. We're doing scenario planning, the most important thing probably in the short term is how they handle repatriation, and so we make sure we understand what our unremitted earnings that are permanently invested, and make sure that number we understand it well, and impacts how they might treat that. That's probably the biggest short term item. With respect to border tax, personally I think it's nuts, but we'll see what happens.

Okay. And then an update, 777X where do you stand with that opportunity on 777X?

Obviously as the entry into service gets closer, we're getting firmer understanding on what's there and what we're winning. It's still a little early. We have some programs that we're still bidding on. So just not quite ready to give the content ship set on that, other than it will be above our legacy content of $1 million.

Great. And then last one for me, Wayne, just an update on currency and hedging, and how much of a tail wind you're looking this year, 2017 versus 2016 relative to EPS?

So, we're going into 2017 about 80% hedged, and that impact is favorable versus 2016. I think the guidance we gave you is sort that the favorable benefit basically offsets the start-up cost of our fiber line in France and our Morocco engineered core facility there. So the exposure we have of 20%, if you think about it, that is about a $2.5 million impact EBIT for the full year.

How hedged are you on the 18 at this point?

I think it's in the 40% to 50% range. Somewhere around there.

Got it. Thank you guys.

Thanks, David.

And ladies and gentlemen, that does conclude our conference for today. We thank you all for your participation. You may all disconnect.