Hexcel Corporation (HXL) Q4 2011 Earnings Report, Transcript and Summary

Good day, everyone and welcome to this Hexcel Corporation Fourth Quarter and Fiscal Year 2011 Earnings Release Conference Call. As a reminder, today's conference is being recorded. For opening remarks and introductions, I will now turn the call over to Mr. Wayne Pensky, Chief Financial Officer. Please go ahead, sir.

Great. Thank you. Good morning, everyone. Welcome to Hexcel Corporation's 2011 fourth quarter and full-year earnings conference call on January 26, 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 2010 10-K, our third quarter 10-Q and last night's press release. Lastly, this call is being recorded by Hexcel Corporation and is a copyrighted material. It cannot be rerecorded or rebroadcast without our expressed permission. Your participation on this call constitutes your consent to that request. With me today are Dave Berges, Hexcel's Chairman and CEO; and Michael Bacal, our Communications and Investor Relations Manager. The purpose of the call is to review our 2011 fourth quarter full-year results detailed in our press release issued yesterday. First, Dave will cover the markets, then I'll cover some of the financial details and Dave will return for some final comments on the year.

Thanks, Wayne. Good morning, everyone. We had another strong quarter that has enabled us to complete a very good year for Hexcel. The fourth quarter sales were $355.3 million, up over 14% from the same period in 2010, our seventh straight quarter of year-over-year double-digit growth. Revenues were stronger than typical for the fourth quarter, and we had great leverage on incremental sales with operating income of $49.4 million for the quarter, up 59% improvement over last year and adjusted diluted EPS of $0.33, a 65% increase over 2010. For the year, sales were up almost 19% to nearly $1.4 billion. Adjusted EPS for the year of $1.24 was just above the high end of our most recent 2011 guidance. Throughout the year, we executed well and made major strides in improving our advanced -- adjusted operating margin. We finished the year at 13.6% over 200 basis points better than 2010 as we delivered 25% operating leverage on the incremental $219 million of sales growth. Now let me cover the markets using constant dollars to describe the sales trends. Commercial Aerospace sales of $211 million in the quarter were up 21% at constant currency from 2010's fourth quarter, with growth in all areas of this market. Revenues from new programs, which include the A380, 787, 747-8 and A350, increased by more than 20% for the quarter compared to Q4 2010. And again, that accounted for more than 25% of our total Commercial Aerospace sales. Year-over-year sales to legacy platforms at Airbus and Boeing were up over 15% for the fourth quarter in 2010, in line with expected demand for the announced build rate increases. Sales to other Commercial Aerospace, which includes regional and business aircraft were again up over 30% compared to the fourth quarter of the prior year. For the full year 2011, Commercial Aerospace sales increased over 27% with combined sales of Boeing and Airbus accounting for approximately 82% of this market segment. Sales for regional and business aircraft grew to $150 million, a 34% improvement over 2010 but still short at the $200 million peak in 2008. Sales to Space & Defense markets were $77.1 million, down about 8% on constant currency versus our record fourth quarter of 2010. Historically, sales in the Space & Defense market are lumpy from quarter-to-quarter, as orders from many programs tend to be campaigned. For the full year, sales in this market were up 2% over 2010 levels, driven again by rotorcraft, where we continue to benefit from growth in new programs, as well as composite blade initiatives. In Industrial markets, sales for the fourth quarter were $67.5 million, up almost 28% year-over-year in constant currency. It's driven by a dramatic improvement in wind sales from the prior year's weak level. For the full year, wind sales were up more than 15% and grew sequentially every quarter but are still about 25% below their 2008 peak. Now let me turn it back to Wayne for some additional financial comments.

Thanks, Dave. Our reported diluted earnings per share for the quarter of $0.39 includes a $5.8 million benefit primarily from the reversal valuation allowances against net operating loss carryforwards in Belgium and U.S. foreign tax credits carryforwards as a result of our improved performance. Excluding these out of period benefits, our adjusted earnings per share for the quarter was $0.33 versus $0.20 from the fourth quarter of 2010. Gross margin of $85.6 million for the quarter was 24.1% of sales, as compared to 21.7% in the fourth quarter 2010, [Audio Gap] strong sales volume. Our operating income for the quarter was $49.4 million, or 13.9% of sales, as compared to operating income of $31 million, or 10% of sales in 2010. Selling, general and administrative cost in constant currency were almost 3% lower in the fourth quarter 2011 as compared to the 2010 period due to lower variable compensation and legal expenses. R&T expenses increased by about 5%. These 2 line items essentially offset each other, allowing all of our incremental gross margins to flow through to operating income. Our interest expense for the quarter was $2.3 million, as compared to $4.2 million a year ago. We're benefiting from the lower rates from the July 2010 refinancing. The February 1 bond redemption and lower borrowings. We also had some onetime benefits in interest expense this quarter and we expect that our go-forward interest expense run rate will be $3 million to $4 million per quarter. Our effective tax rate for the quarter was 17.2% as our improved performance and outlook allowed us to reverse valuation allowances against net operating losses and foreign tax credit carryforwards that we previously thought would expire unused. Excluding these benefits from summary 1 in 2010, our effective tax rate for the quarter would have been 29.5% as compared to 25.7% in the fourth quarter of 2010. For 2011, excluding out-of-period tax benefits, our effective tax rate was 30.1% versus the full year run rate of 29.4% in 2010. Overall estimated effective tax rate remains at 32%, reflecting improved profitability in higher tax rate countries and that the U.S. R&D tax credit has not yet been extended for 2012. Our full year 2011 free cash flow was $12.5 million as compared to almost $78 million 2010. Increased earnings were more than offset by substantially higher levels of capital spending and additional working capital for our projected growth. Our accrual base capital expenditures for the year were $184 million as compared to $61 million in 2010. This included $80 million in the fourth quarter, as our previously announced capital expenditure acceleration program has kicked in. Cash on hand, plus available borrowing capacity at year-end, was $254 million. In 2012, we expect our capital spending to be funded by our cash from operating activities and our existing credit facilities. Now let me turn the call back to Dave for some closing remarks.

Thanks, Wayne. So to sum up, 2011 was a great year for Hexcel by almost every measure. We started out the year with worries about the impact of earthquakes, the tsunami, nuclear contamination tornadoes and the global economic crisis. But thanks to years of strategic positioning and focus on markets with long-term growth prospects, we returned to our double-digit revenue increased trend. I think over the last 10 years, we've demonstrated and agility and the commitment to respond well to external shocks but our preferred business model still there to deliver earnings leverage and growth. In 2011, we got the growth we had hoped for. And with it, we managed to deliver 57% more adjusted net income than the best year in our 63-year history. We've never felt better positioned and reaffirm our December 7 guidance for the year and now we'd be happy to take your questions.

[Operator Instructions] And we'll go first to Steve Levenson from Stifel, Nicolaus.

Can you tell us a little bit about the news that was out the other day about the land purchase down in Decatur and how the additional precursor capacity fits in with the other capital expenditures?

Well, precursor and carbon fibers are our biggest capital expenditures, so you probably shouldn't be surprised to see that we picked up a little another piece of land in Decatur, Alabama. It's right next to our existing facility where our infrastructure can be shared. We mapped out our long-term growth footprint a number of years ago, and to a great extent, all of our existing locations is where we expect to stay and expand a couple of locations we need to lease a couple of more buildings or acquire a little bit more land. Decatur being one of those.

And is it room for one line there or do you expect to have room for multiple?

There's room for multiple lines, room for our long-term plan actually.

Okay, thanks. Is there anything you can say about A350 right now? I guess some of the bottlenecks have been relieved and a lot of parts have been delivered to final assembly which hasn't yet started. But do you see a sort of parallel to what Boeing has done with the 787 where they'll be adding your frames to sit and wait for certification since short of schedule?

I'm pretty pleased with what I see with the A350, working with all of the partners and subcontractors, working and developing, improving output, yields, lots of activities over the bottlenecks that were reported a number of months ago seemed to have cleared and I'm pretty excited about the whole program.

And we'll take the next question from Amit Mehrotra from Deutsche Bank.

25.5% incremental margin quite strong in 2011, is that a number you're comfortable with for 2012? And can you talk about some of the puts and takes that may drive that higher or lower?

Well, I think 25% incremental has a nice ring to it, for sure. We targeted over 20% but didn't quite expect that we'd do that well. The second half was particularly strong. I think some of that was helped by our buildup of inventory for what's to come. But pretty much, I just think we had good performance all the way around and big, big growth. As I've said before, it gets a little tougher as you start to expand capacity as we are now you start to see the increase in depreciation, higher cost of premium shifts and training, but I think maintaining the 24% to 25% gross margin going forward is good, and we'd hope to get the expansion of operating margins by controlling the overhead cost after that.

That's great. That's helpful. And then just lastly if we look at the 2011 sales, second half outpaced sales in the first half, which I guess usually is in the case to the seasonality. How should we think about cadence in 2012 sequentially up to the year or will '12 be more representative or more typical year with the stronger first half?

Well, I think the first half is typically stronger as you point out but if you've got a growth pace that is in the high double digits as we had last year, even the second half can outweigh the first half. I don't have a quarter-by-quarter outlook here but I would expect first quarter to be stronger than the fourth quarter for sure. This last fourth quarter.

And we'll take question from Ken Herbert from Wedbush Morgan.

Just wanted to follow up on the Commercial Aerospace outlook. I know this year had very, very good growth from A380 and the 747-8. As you look out to 2012, to what extent will 787 and A350 may be offset some slower growth on the larger aircraft?

I think, as I think I went through last quarter, I still feel the same way, the A380 was the biggest year-over-year driver this year and is the biggest in that segment. It's gotten more growths to come. Build rates that I've seen Airbus announced publicly look to have another 15% to 20% step-up in them. How we're timed for that is always a little tough to tell on big programs -- on new programs. But the A380, I expect to continue to grow. After that, the 787 and 747-8 are both starting to -- should start kicking in more. They've been fairly flat for a number of quarters as Boeing has gotten their production system rolling, but I'd expect those to be bigger contributors relatively in the sequential thinking, anyhow in the next couple of years. And then after that, we have the A350 and then the re-engining of the A320 and 737 assuming we have increased content on those programs. So I think, coincidentally, these are layering in pretty nicely, and we ought to be able to have a good, orderly double-digit growth track.

Now that's very helpful. Was there a -- I mean because it sounds like from a lot of commentary from the 787 has been -- and like you just indicated sort of flat sequentially. As you look in 2012, is there a particular quarter or particular inflection point where you might see a material step-up in that program? Or anything we should be thinking about from that standpoint?

Well, it shouldn't. I mean, those things happen. But we're shipping to many, many subcontractors at various tiers in the whole supply chain. So those things tend to normalize and create a pretty steady trend. So I wouldn't expect to see any particular pops. And if I did, I probably wouldn't disclose it on the call.

And the next question comes from John McNulty from Credit Suisse.

This is Abhi Rajendran calling for John. Your wind business had a more typical seasonal pick-up through the third and fourth quarters of 2011. Could you talk a little bit about what you're seeing with your customers in terms of orders and deliveries for 2012 and what sort of growth you might expect in your business this coming year?

Well, it's been a tough couple of years for the wind industry with tight credit and global economy, changing rules China, low natural gas prices, uncertain or expiring incentive programs. I still think long-term desire for renewable clean energy and the resulting jobs creation, energy independence makes it attractive. On a megawatt basis, thanks to big wins by Vestas particularly in Europe, Canada and South America the backlog is almost double what it was in 2008, which was our peak wind sales here. So assuming credibility, we do expect continued double-digit growth in 2012, albeit form a lower level than 2008. So it certainly doesn't look as -- the visibility isn't as clear and uncertain as aerospace but the potential for relative and sequential growth is still really encouraging for us.

Great. And could you just remind us again what the typical lead time is in that wind business from when your customers purchase of products, to when they build out their end products, and if that's changed at all kind of in the last year or 2 as uncertainties has grown?

I don't know if we can even answer that, because I don't really know if there's an orderly pattern to that. It's probably different region by region. I mean, our plants in the U.S. and China are just around the corner from Vestas. So we make it. They build the blades. How long it takes the blade to get installed in our location in North Dakota, I'm not clear.

Okay. Got it. And one last quick one if I may. Could you just talk a little bit to demand for rotorcraft blades in the Space & Defense segments, as well as how the wind down in Iraq and other areas might impact your core business and if there's some opportunities to kind of offset that?

Well, we continue to think that diversity of our positions and the move to a more composite rotor blades by almost every helicopter maker in the world and the growth in the V-22, the A400M and the Joint Strike Fighter, which are much more composite intensive than the airplanes they replace, all help offset the drip drip drip of the hundred other defense programs that we participate in. So rotorcraft, I haven't looked at recently but rotorcraft was growing at about 15% a year, helping to offset the F-22 ending and a couple of other programs that have slowed down. So we still think we're going to be able to see single-digit growth despite all the handwringing.

And the next question will come from Avinash Kant from D.A. Davidson.

A few questions. The first one, could you comment a little bit about your capacity utilization at this time, and where do you see it going throughout the year? I know you are building capacity but if you could give us any reference, that would be great.

Well, we don't have an absolute number that makes any sense for the total company, but I'd say, other than wind, and just think a minute -- I think other than wind, we're adding capacity in just about every area, which suggests we're in the 90% to 105% capacity range as a new line gets put in and gets qualified whatever that capacity of that line is a surplus capacity until it fills up and we'll go to the next one. But with a double-digit growth trend, I think you could just sort of put us down for being at the high end of the capacity utilization continuously for the next few years.

And you do not expect any specific margin impact as those capacities come on line?

I expect to cover any negative depreciation costs with the incremental leverage of factory operations and productivity.

Okay. And the second question was on JSF. Of course, there's been a lot of concern about that program. Could you talk a little bit about how much visibility do you have in the JSF program, and where do you see it going?

We don't have any more visibility than you do and I don't have a more informed opinion about where it's going than you do. I would just remind everyone that it's not a very big part of our Space & Defense segment, but has the potential to be. And to the extent more airplanes are being built than were 2 years ago, we are getting incremental growth from the program. So whether it will be as big and exciting as people thought it would be 15 years ago, I don't know. But it does give us incremental sales growth until such time that it completely ends.

We'll go next to Noah Poponak of Goldman Sachs.

Any update or new thoughts on where cash from ops comes-in, in 2012?

Well as Wayne said, we still think we can comfortably fund our accelerated expansion program for the next few years from cash from operations and our existing credit facility. The CapEx payables surged in December and typical seasonal impacts will surely result in the negative cash in the first quarter. But from there, I'd hope we could be fairly balanced for the rest of the year. We haven't given specific guidance on 2012 cash but if you just convert the EPS and depreciation guidance into EBITDA and match it against our CapEx guidance, you get a $50 million deficit or so that we've got to deal with before any working capital changes. But again, with cash and available credit of $250 million, we're pretty comfortable with our expansion.

Okay. That's helpful. And then, with that expansion program and the extra D&A that you just alluded to overcoming from a margin perspective, does that mean that your next year, much more likely to just kind of hover around that just above 20% incremental area, versus this year when you were able to really generate significant upside to that? Or do you still see a bunch of opportunities to get more efficient or productive, and can you speak to what those are?

Well I think we've made a lot of progress on getting efficient productive and the year's results show that. I think though the biggest driver, quite frankly, is what the growth rate is. So if you assume gross margin stay in the neighborhood of 24%, 25%, and you don't get a lot of leverage on the gross margin because of the expansion programs, then we can do a good job at holding our SG&A as we have for the last 5 years. It's the amount of leverage is pretty much based on updated growth trend.

Yes. Okay. And then I've been on and off here. Have you said specifically what you expect the growth rate in wind to be in '12 versus '11?

No. But we think industrial growth double digits principally driven by wind. So the backlog investors gives us quite a bit of comfort that we should be able to get through 2012 with double-digit growth again.

[Operator Instructions] And we'll move next to Mike Sison from KeyBanc.

In terms of regional business jets, had a nice recovery in '11 versus '10, how do you see that market shaping up for '12?

I don't feel very well informed on that. There's so many players and there seems to be some share shifting, if I read the press right, amongst some of the players. The big aircraft are more interesting for us and they seem to be holding up a little bit better. I, quite frankly, was a little surprised at how strong 2011 came in. Maybe 2010 was our official low. We just sort of straight-line that because we don't know any better and I don't have much more I can guide you than that.

Okay. And then in Space & Defense, looks like you had some orders, sort of delayed in the fourth quarter. How big was that and do you expect that to come back pretty quickly in the first or is it sort of flow-through -- throughout 2012?

Well, we had some timing anomalies in the fourth quarter that are not a typical these particular ones in Asia and Europe. But they weren't big, nothing is. There are so many programs, or there's nothing that jumps out in that quarter versus any other quarter. The year before happened to be a very, very strong quarter, and it was similarly inexplicable. I think we're still going to see single-digit growth in 2012. I don't know quarter-by-quarter though.

And we'll move next to Eric Hugel from Stephens, Inc.

Can we talk about on the Engineered Products segment? It's been a while since we saw a number sort of ramp up 14.4 levels. Is there anything there or are we just looking at mix?

Yes. Harry, we got a little bit spoiled last 7 or 8-quarters, been above 16% which for that business is great. This quarter we had a little bit of development cost associated with new programs and a little start-up cost associated with some of the new product configurations that would be bagged themselves probably tend to mitigate going forward. So I'll just view this as the sort of a normal ins and outs of new program developments.

So we're thinking on a go-forward basis, that the Engineered Products, we should looking more in let's say around the 15% than the 15%, 17%?

Yes, we're in 15% to 16% range so that's a good outcome for us guys.

Okay. Can you talk about, in terms of your wind business, Vestas, I mean obviously they've been having production problems. They've been sort of talking about if the U.S. production tax credit isn't extended, seeing a meaningful cut in production. Can you sort of talk about what kind of visibility you have into their backlog? Because while you're looking at sort of good numbers for this year, there certainly has to be a risk that as we go forward beyond this year, there's a substantial drop in that business?

Well, there could be in the U.S. if that's your point if the production tax credit isn't extended. This is an old story. It's happened I think 5x in the 10 years I was here. They go to the 11th hour and then suddenly gets extended. Nevertheless, because Congress waits so long we do end up with big swings in installations in the U.S. This market is a lot more global than the U.S. of course and Vestas is not a predominant player in the U.S. I think there are orders last year, which are published, many of them were published, not all of them. I think about 25% of the orders were in the U.S., if I recall. So maybe that becomes more difficult. I would suggest that Vestas is also pretty active in the political arena, letting people know what a great jobs industry this is, how many jobs they've created in the U.S. and I would suggest some of that talk is to wake Congress up, to get them to realize there are jobs there in the renewable energy field, they're very attractive and that they need to move on the PTC.

Has their production levels work their way, have impacted you or worked their way through sort of your orders yet?

Well I won't speak for their problems. I mean, whether or not they've solved their problems ...

Well, anybody just in terms of the supply, the impact of the supply chain.

We'll we had a very strong growth quarter and we had 4 in a row. And the way we think about it is the extent they've got production problems but don't have orders canceled, our sales are just delayed. So the fact that we've had growth maybe is the answer to your question. But if their output has been delayed because of those production problems, it just means the backlog is stacked up a little longer in front of us. So I still feel pretty good about 2012 for Hexcel.

And just lastly, one more, maybe just some visibility as to when you guys might get some more sort of visibility as to what the opportunities are on the sort of the MAX and NEO, what kind of time frame would you contemplate?

Oh, I think that would be years, not quarters. I mean, we had, we know what pieces and parts they're wanting to move to composites, but I don't ever count anything is in the bag until new programs are fully certified, because they can make changes as they go through. Normally the changes are to the benefit of composite companies as they wrestle with weight problems, but I think it will be a while before we'll have any clear answer for you on that.

And that concludes today's question-and-answer session and also brings us to the end of the presentation. Thank you for your participation and have a wonderful day.