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Hexcel Corporation (NYSE:HXL)

Q4 2008 Earnings Call

January 22, 2009 0011 a.m. ET

Executives

Wayne C. Pensky, Chief Financial Officer

Analysts

Howard Rubel - Jefferies

John McNulty - Credit Suisse

Richard Safran – Goldman Sachs

Nigel Coe – Deutsche Bank

Al Kaschalk - Wedbush Morgan

Stephen Levinson - Stifel Nicolaus

Karl Oehlschlaeger - Macquarie Securities

Cristina Fernandez – UBS

Mike Sison - KeyBanc

Michael Lew - ThinkEquity

Operator

Good day, everyone, and welcome to this Hexcel Corporation’s fourth quarter 2008 earnings conference call. As a reminder, today’s conference is being recorded. For opening remarks and introductions, I would now turn the call over to Mr. Wayne Pensky, Chief Financial Officer. Please go ahead, sir.

Wayne C. Pensky

Thank you. Good morning, everyone. Welcome to Hexcel Corporation’s 2008 fourth quarter earnings conference call on January 22, 2009. 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 2007 10-K and last night’s press release.

Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be recorded or rebroadcast without our expressed permission. Your participation on this call constitutes your consent to that request.

With me today are Dave Berges, Hexcel’s Chairman and CEO; and Michael Bacal, our Communications/Investor Relations Manager.

The purpose of the call is to review our 2008 fourth quarter and full year results detailed in our press release issued last night. First, Dave will cover the markets, then I will cover the financials and then Dave will return with some comments on our outlook.

So let me hand the call over to Dave.

David Berges

Thanks, Wayne. Fourth quarter sales of about $290 million were well below our original expectations, almost 9% lower than last year, due primarily to the impact of the Boeing strike. Net income from continuing operations of $28 million is more than double last year aided by tax benefits recorded in the quarter. Excluding one-time items in both ‘08 and ‘07’s fourth quarter, adjusted net income was down 18%, again primarily due to sales and margin lost to the Boeing strike.

For the full year, we saw sales grow by about 13% or 11% in constant currency, in line with our expectations led by a strong growth in each of our target markets.

Net income for the year increased over 75%, reflecting our higher sales levels, gain on the sale of a joint venture, and the recognition of certain tax benefits. Excluding one-time items, adjusted EPS were $0.82, up 15% for the year.

I’m sure you are more concerned about our outlook for sales going forward, but let’s first cover the quarter just closed and I’ll come back after Wayne with some thoughts about the future.

As usual, in talking about markets I’ll use constant dollars to comment on the trends. For reference again, our reported top line sales for the quarter were down 8.8% from last year as reported, but only 5.1% on a constant currency basis. So the apparent sales decline of about $28 million was $16 million in real terms for the quarter.

Commercial aerospace sales were about $143 million for the quarter, down 13% in constant dollars from last year, due again to the Boeing strike. In fact, our sales to Boeing and its subcontractors were down 40% as compared to the fourth quarter of 2007.

In the second half of 2008, Boeing Commercial delivered 107 fewer airplanes than in the second half of 2007. If you assume an average Hexcel content of $400,000 to $500,000 per plane, the damage to our revenue should total $40 million to $50 million in the September to February time period. We’re now returning to pre-strike levels of activity on legacy programs

Sales to Airbus and its subcontractors were down slightly for the quarter as the fourth quarter of 2007 was particularly strong and some of our customers had year-end inventory initiatives.

In our other commercial aerospace grouping, a sub-markets that’s been growing by over 20% for two years, sales were flat compared to last year for the quarter principally because business jet activities have slowed.

For the year, sales to the entire commercial aero market were up over $88 million or 13.5% on a constant currency basis. As a result of the strike, sales to Boeing and their related subcontractors were wholly flat as compared to 2007 levels, losing all of the significant growth they generated in the first nine months of the year. Airbus and other aerospace sales were up over 20% for the year, thanks to a very strong first half.

Sales to space and defense markets were about $77 million for the quarter, up 10% in constant currency. For the year, we had growth in excess of 16%, well above our historic 8 to 10, as we benefited from a broad range of programs in the US, Europe and Asia, including rotorcraft, fixed wing attack, transport, and satellite programs.

Constant dollar sales for our industrial markets of $69 million were essentially flat for both the quarter and the year versus 2007, glass prepregs for wind turbine blades continued strong, growing in the high teens in constant currency for both the quarter and the year. As expected, wind finished the year at more than half of our 2008 industrial market sales.

We’ve now begun regular production at our new China wind plant and started construction on our new new glass prepreg facility in Colorado.

Sales for the rest of the industrial market, which includes recreation, auto and other general industrial, were at multi-year lows for the quarter reflecting both weak markets and selective portfolio pruning.

On a positive note, we did make our first carbon fiber shipments to the American Centrifuge program during December. We expect sales from this roughly $100 million contract to continue in 2009 and then ramp up in 2010 and 2011.

Now, let me turn the call back to Wayne for some additional comments on the financial performance.

Wayne Pensky

Thanks, Dave. Gross margin of about $62 million for the quarter was 21.4 % of sales, a decrease from the 23.4% gross margin for the fourth quarter of 2007 and slightly less than the 21.5% for the third quarter. Over production volumes resulting from the Boeing strike along with incremental fixed and start-up costs at our new facilities in Europe and China were leading contributors to this year-over-year decline.

For the entire year, gross margins declined by about 240 basis points due to a variety of factors, including about 125 basis points of incremental fixed and start-up costs associated with the new facilities. We expect margins at our new facilities to continue to improve throughout 2009, though they will remain below our average until production expands to support higher sales volumes.

Also for the year, we estimate that the extraordinary volatility in exchange rates, energy and oil-based import material costs cost us at least another 125 basis points in gross margin, but these issues have for the most part now subsided or have been offset by pricing actions.

Selling, general and administrative expenses were well controlled, down $5.1 million or 18% to $24 million for the quarter. The decline reflects cost actions taken in response to the Boeing strike, reduced expectations for incentive compensation and exchange rates. For the year, SG&A expenses were $1.1 million less than 2007, so they were down to 8.5% of sales versus the 9.7% the previous year.

We’ve invested a lot of energy this year in implementing tax planning strategies to use more the net operating loss and foreign tax credit carry-forwards that we have available as well as the lower effective tax rate going forward.

The total one-time tax benefits we recorded this year were $26.2 million, including $12.6 million this quarter. We do have additional foreign tax credit carry-forwards available against which we have recorded valuation allowances, but we will not reverse these evaluation allowances until such time that we believe is more likely than not that they’re realizable.

So excluding these one-time benefits, our effective rate for the quarter was 38.2% as compared to 37.7% in last year’s period. And for the year, it was 37.8% as compared to 38.2% for 2007 and we expect further improvement in 2009. Our net debt decreased by $3 million in the quarter to $344 million.

For the year, net debt increased by $56 million as a result of increases in capital and spending and working capital usage to support business growth. These increases are partially offset by $22 million in proceeds from the joint venture sale last quarter. So we ended the quarter with almost $51 million in cash on hand and we had no amounts outstanding under our $125 million revolver facility.

After considering the outstanding letters of credit, which reduce our available borrowings under our revolver, we had about $162 million of cash in available borrowings at year-end, up about $20 million from the beginning of the year. As a reminder, our lead banks in revolver are Deutsche Bank and Bank of America.

Program delays and softness in certain of our markets have allowed us to lay some of our capacity expansion projects and we now plan to limit capital spending to $100 million in 2009. Much of 2009’s capital spending will be front-end loaded with the funds going towards the completion of our latest carbon fiber expansion in Colorado wind projects. At this reduced spending level, we expect to be cash flow positive for the year, although we will be negative in the first half of the year as a result of the timing of the capital spending and seasonality factors.

Before Dave further discusses 2009, let me add one more item that will help. As you know, we have a fairly active hedging program for our euro and British pound exposures. At the operating income line, we have about 75% of our 2009 estimated exposure hedged at rates comparable to our 2008 hedge rates. For the fourth quarter, the 2008 hedge rates were slightly unfavorable compared to the 2007 rates.

Remember, a strong dollar helps us, so if the dollar stays where it is currently, it will provide a small tailwind compared to 2008 on the 25% portion that is not hedged. Roughly, every 5% strengthening of the dollar in 2009, adds just over $1 million of operating income, though it does reduce our sales by about $24 million.

Now, let me turn the call back to Dave for some comments on our current outlook.

David Berges

Thanks, Wayne. Like many other companies, we’re currently providing only limited 2009 guidance due to global economic volatility and the potential effects on our customers. I’m hopeful that things will calm down as the year progresses and that we can provide more insights with a greater degree of confidence.

But I can share with you that our current 2009 sales plan assumes total revenues to be flat or slightly up on a constant currency basis. If that holds true, we are targeting modest growth in adjusted EPS to continue our seven-year streak of improvement.

In commercial aerospace, as most of you know, our materials for Boeing and Airbus legacy programs are typically delivered six months before aircraft assembly. So while we feel confident about the first half sales to these, our largest customers, our second half of 2009 is dependant on their forecast for 2010. While neither currently has indicated a significant decline in 2010, they are being more cautious until financing and backlogs are thoroughly reviewed with the airlines and leasing customers.

In addition to legacy programs, new programs could be a factor in the next two years. As delays for new programs such as the 787, 747-A, the A380 and A350 have unfortunately been the rule rather than the exception recently, our plan assumes no growth in this area for 2009. And we hope that any upside can offset the impact of any legacy softness in the second half. We remain excited about the order book and potential of these new programs, as well as the ongoing mix shift to more composite-intensive wide-body aircraft.

Beyond Boing and Airbus, our other commercial aerospace submarket, has a five-year growth rate of over 20% that now represents almost $200 million. We expect this submarket to decline in 2009, as medium and small aircraft OEMs have clear signs of pressure in smaller backlogs to buffer them.

Turning to space and defense, 2008 16% growth rate was well ahead of the historical pace. While we still expect growth, our plan assumes a return to single-digits.

In our other core market, wind energy, we continue to believe 2009 sales would grow at double-digit rates. While there are obvious concerns with respect to end customer financing, most growth forecasts were starting from very high rates. We expect that the continued global move towards renewables, plus incremental capacity additions by our customers, will allow Hexcel to grow through these troubled times, though perhaps at a lower rate in the short-term.

The rest of our industrial markets, including rec, automotive, are clearly seeing the impact of the global economic weakness, but are now less than 15% of our total sales. Sales of the American Centrifuge program should offset any further weakness in these submarkets.

While the current global recession is making it much harder to deliver growth for the short-term, I feel compelled to remind you the things that Hexcel has going forward over the long-term.

Boeing and Airbus have backlogs in excess of 7,400 orders and many of these planes will ultimately need to be built over the medium-term. Backlog increased again in 2008, even in the second half, as they still took in almost 70% more orders than they’ve delivered for the year.

Within that order book, we are seeing a major shift in newer wide-body aircraft. Our content on wide bodies is typically two to five times larger than that of current narrow bodies. Military aircraft looks good for years with rotorcraft driving the short-term, the new composite-intensive aircraft driving the long-term.

In our industrial markets, the global focus on climate change, oil independence and government subsidies have only gotten stronger in recent years and demand for our products for both wind and uranium and Richmond tube should continue well into the future. It’s hard to find any good economic news of late, but I still feel great about Hexcel’s positioning for the long-haul. prudence, patience, and persistence are the themes for the year.

We’d be happy to take your questions now. Operator?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) We’ll take our first question from Howard Rubel. Please go ahead, sir.

Howard Rubel - Jefferies

Thank you. Good morning.

David Berges

Good morning, Howard.

Howard Rubel - Jefferies

Gross margins were okay, all things considered. You seem to have done a nice job of being able to eliminate some of the operating leverage that’s hurt you in the past with sales declines. What did you do? And then related to that, Dave, you kind of talk about normal margins there, are we sort of targeting 24 to 25%?

David Berges

Let’s see. The first question, what did we do? Strike or a sudden stoppage, it’s pretty difficult to shed costs when you know things are going to come back, and it’s unexpected and it was longer than we expected. But we took out a bunch of people on a temporary basis. We tried to globally cut back on all the usual things that anybody does when they are in trouble. And we had some improvements in plane performance. You might recall in the second quarter, we were talking about having a pretty big past due position or backlog to our customers because of capacity constraints. Our capacity gradually has been coming on line.

The strike helped us work down the backlog, so some of the premium costs that we’ve been punishing ourselves with over the last nine months diminished. Obviously, a little bit less pressure on some of the oil commodity and materials prices. So things started to look a little better in the fourth quarter, but it’s real hard to tell exactly what the net would have been with the anomaly of the strike in there.

Your second question, Howard?

Howard Rubel - Jefferies

Well, kind of related to that is you talked about sort of at some point normal kind of – you talked earlier your comments about normal gross margins and it would seem to me that you’re sort of trying to target in the 24 to 25% range, is that still a fair…?

David Berges

Well, it certainly sounds like an interesting target. I’d think for 2009 that’d be pretty aggressive if we don’t have the growth, principally because the incremental operating costs of the new plants. So we’ve obviously got the three that we talked about before. Now, in addition we have China and by mid-year we’ll have Colorado. Until those plants are up to serious volumes, some of them even require additional lines to support the future growth. They are going to be a bit of a drag on our margins.

So if you go back to 2007, there were a number of things that happened in 2008 that have kind of cleared or otherwise have been adjusted via pricing. Those are things like commodity costs and energy costs and some of those. So those have moderated, but the new plants will continue to be a drag in 2009. So I’d think we should expect to be somewhere between 2007 and 2008 as we go forward for this year.

Howard Rubel - Jefferies

And then one just longer-term question. You inherited the backside of a commercial aircraft down cycle when you came to Hexcel in ’01, I guess.

David Berges

Right.

Howard Rubel - Jefferies

And tell me how it feels today. I know it hurts, but tell me how it feels and what do you think you’ve got in your toolkit to sort of deal with some of the uncertainties that you see before you?

David Berges

I’d say the difference now, Howard, is that on September 12 of 2001, we all knew that there had to be a drop. In fact, at the time we thought people may never fly again. So we really at the time realized we’re going to be a smaller company for a very long time. At least that’s how we felt then. It obviously didn’t happen. It wasn’t that bad. Things went down, but it was nine months later that the Boeing dropped their line rates. Airbus was in the midst of a growth cycle, so they just sort of stopped their growth. So we had pretty good advanced knowledge of what needed to be done, and we could move out well in advance. What’s a little bit different this time is, if you look at the analyst expectations of build rates, they vary wildly and nobody is certain. So I don’t know for certain that there is going to be a decline in airplane builds. So we have to play it by year; we just have to be conservative and cautious. I don’t know there is going to be a drop, so I don’t see taking big, big cuts in anticipation of the drop. Another thing that’s different is the shift of bigger aircraft and these new aircraft that are coming online and still have a tremendous interest in the marketplace.

This is way oversimplified. But since you bring up 2001, I just happened to notice that aircraft deliveries by Boeing and Airbus in 2008 were just about the same as they were in 2001. But our sales to commercial aerospace are up 35%. That’s not because I have done a good job selling. That’s secular penetration. So we have got a benefit that a lot of our peers don’t have. And while I would love to be excited about our absolute growth potential, and I’m less so I’m encouraged by our relative growth potential in the industry.

Howard Rubel - Jefferies

Thank you.

Operator

And we will take our next question from Mr. John McNulty from Credit Suisse. Please go ahead, sir.

John McNulty - Credit Suisse

Yes, good morning.

David Berges

Hi, John.

John McNulty - Credit Suisse

With regard to your CapEx, I know you have dialed it back pretty dramatically and because you’re through a lot of the near-term plant needs. When you look out over the next few years, and you’ve got this big A350 contract, when do you have to start ramping up CapEx again do you think in order to get ready for that contract? Admittedly it’s out a few years but it also takes a couple of years to get these plants up and running and qualified.

David Berges

Well, I think you know what we would hope to do is sort of steadily increase the capacity in blocks. It’s an efficient way for our team to be able to add capacity. I still think we would like to do that. So we need to see a few more cards on what’s going to happen in the marketplace. I think by mid-year we will have a better view of what ‘10 and ‘11 are going to look like. We need capacity for more than just the A350, but I would hope that we will see signs enough that everything is going to be okay and we will start layering it on again 2010, if not the latter part of this year.

John McNulty - Credit Suisse

Okay, great. And then with regard to the USEC business, can you just give us some color as to how steep the ramp up is for that in terms of when you start to see the revenue coming in. I know it’s – 2010 is supposed to kind of be the first big year, but can you give us a little bit of color as to how steep that ramp up actually is?

David Berges

I don’t have a real good visibility on that because it’s principally going into one contractor who then sends it to another and I don’t exactly know what pace they want to increase. I would just guess that that 2010 and ‘11, the contract goes through 2011, that those would be the bigger years, but ’09 will be sort of a steady contributor versus 2008.

John McNulty - Credit Suisse

Okay, fair enough. And then just a last question, with regard to your raw materials and energy, , actually I think Wayne had said even earlier what the exposure or damage or impanct was in 2008. How quickly has energy prices come down and has raw materials come down, how quickly do you have to pass that through to your customers in the form of price or is it something that’s sticky just based on the type of contracts that you tend to sign?

Wayne Pensky

Most of what we do are longer-term contracts. A short contract for us is a year and a long contract for us is infinity. So we don’t have sort of the quick impact in reaction either way, on the way up or on the way down. Many of our supply contracts are also matched up or go for a year, oftentimes a calendar year. So during the summer, those commodities that weren’t tied down did slow it up and not all are tied down. Those that were not floated up did often cause some pressures. We started positioning for our new contracts that were coming due with our customers to start getting some recovery. And so it sort of has a way of normalizing all of the action. I think we are clearly getting some benefit now for some things like acrylic nitrol that hurt us earlier in the year, but I think the swing is likely to stabilize a lot in 2009 and I hope we won’t be constantly talking about those variables.

John McNulty - Credit Suisse

Okay. So just when we think about the margins overall, particularly your operating margins, you’ve got raw materials and energy coming down, you’ve done some restructuring which or at least it’s a limit, the people cost side, you had some plant issues in 2008 that at least shouldn’t be quite as big of a headwind and you have the strike impact in ’08 that at least shouldn’t be too much of one in 2009, certainly the shock value of it won’t be, so how should we think about the operating margins, how much bigger can they get in 2009 versus 2008 with all those things and having worked against you in the past, even in assuming 2009 is going to be a flat revenue type environment?

Wayne Pensky

Well, if 2009 was flat and study it’d be easier to answer and we probably would have given you a more thorough guidance. I think my big hesitance to getting that specific, John, is that first half second half is a question mark. I know everybody would love a little more visibility but a couple of our biggest customers are saying they are going to declare on 2010 in the spring.

So it’s just not real practical for me to take a stand on exactly what the full year will look like. I think our gross margin should be better than this year, I’d even throw out the fourth quarter because you don’t know what the strike impact, what it would have been without the strike but I think we should certainly have better gross margins than 2008 but I don’t think they’ll be as good as 2007 because of the new plants.

SG&A, I think we did a good job holding it this year obviously in this environment we’re not planning to run away on that. We’ve always sort of set the goal to cover inflation, wage increases with productivity. We did that in 2008 and I’d like to do it again in 2009. If we don’t have the benefit of growth that doesn’t give us the leverage that it has in the past.

John McNulty - Credit Suisse

Okay. Great. Thanks very much for clearing up.

Operator

And our next question comes from Mr. Richard Safran with Goldman Sachs. Please go ahead sir.

Richard Safran – Goldman Sachs

It’s okay. I had my question answered. Thank you.

David Berges

Okay. Thanks Rich.

Operator

And we’ll go to Mr. Nigel Coe with Deutsche Bank. Please go ahead sir.

Nigel Coe – Deutsche Bank

Yes. Thanks. Good morning. Dave, you mentioned the CapEx you referred it looks like it might come back in 2010 or maybe the back end of 2009, what is the key determinate of that facing, is it 350, is it 77, is it a combination of the two?

David Berges

I might say it’s everything because it also includes wind, it includes what happens on JSF. If you were to break our sales, if you throw out the industrial, other industrial which is less than 15%, you can break our sales into big buckets, Airbus being one, Boeing being one, other aerospace being one, space and defense being one, wind being one, and over five years every single one of those has got a CAGR that’s double digits over a five-year period.

So our capital spending isn’t just about the A350, it’s that we’ve got a significant set of businesses here that have a compelling growth story and I think they will over the long-term. We have a bit of a low or a question mark here for a short period and we just need to get our bearings and credit markets need to loosen up because there is just darned little that our end customers do that aren’t affected in some fashion by credit markets.

Nigel Coe – Deutsche Bank

Sure. There is a bit of concern about oil capacity being brought online, carbon fiber capacity being put online, potential first supply demands imbalance and hence prices coming down, can you just talk about what you’re seeing in that markets? And maybe just confirm that falling carbon fiber prices, is that net benefit to you or net detriment?

David Berges

Falling carbon fiber prices would be a net benefit to us because we buy more than we make, most of what we make go into proprietary products that have difficult approvals in long-term contracts. So as we’ve said before we sort of just try to provide ourselves and customers with a real high end of that market. So the lower end clearly are seeing some signs of strain. I’ve heard and/or read of some fiber suppliers in the industrial arena, stopping lines, mothballing lines or plants as they have had to in the past when there was a temporary excess. I don’t have my fingers on exactly what’s happened to price recently but I can’t help to think they will have calmed. Availability, from my view point, availability is something that I’d always like to see because it accelerates the move towards carbon fiber composites. In those years of shortages and there were a number of projects in recreation, in automotive and other that pretty much got stifled because carbon wasn’t available and prices were going up too high. So, I see there is a net plus for the short-term.

Nigel Coe - Deutsche Bank

Okay. Thirdly, on space and defense, I know that you’ve participated in lots of programs and no one program is really a key driver. Is there anything in any of the major program that you participate in that we should be kind of thinking about as far as maybe phasing is concerned or for the whole 2009, I’m thinking here but there is say A400M or maybe C-17.

David Bergers

Some of the big programs, I think you’re aware of would be the Joint Strike Fighters C-17, F-22, F-18. A400M had potential to be big and did have an impact on us this year as they’re doing development work and obviously that’s been delayed. A question you have to ask yourself on anyone of these programs is if one gets slowed or cancelled or funds move away from it, where do those funds move to or what takes it place. So example, the A400M, do the Europeans need the list capacity and will they go to a C-17 or to an A330 variant to get it done in which case, that’s an offset for us. And the case of I often see debate about moves between Joint Strike Fighter versus F-22 and I don’t know what their net is but those are offsetting for us if they move from one to the other we aren’t necessarily heard we may actually gain, same as true of F-18. In helicopters, we participate with all of the biggies and they’re all going very well and ones win is another’s loss but not for Hexcel. Again, we’re pretty balanced between US and Europe. We have a very strong position with European helicopter makers as well as the US helicopter makers. I think the only one, the V-22 is another one that’s a significant program for us. I think the only one that could, well any of them could impact us, but the C-17 has been speculated on for years that its going to drop of and its an important program for us. We have sort of always been prepared for that eventuality but so far it seems to still be dribbling along.

Nigel Coe - Deutsche Bank

And then the quick ones for Wayne and any color on DNA in 2009.

Wayne Pensky

Sure, we’re looking probably another $8 to $10 million of deprecation in 2009 versus 2008.

Nigel Coe - Deutsche Bank

Great, thanks a lot.

Operator

And our next question comes from Mr. Al Kaschalk from Wedbush Morgan. Please go ahead, sir.

David Bergers

Good morning, Al.

Operator

Sir, your line is open. Please go ahead with your question.

Al Kaschalk - Wedbush Morgan

Good morning. Sorry about that. Most of my questions have been answered. I have two that I like to try and clear up. First, can you comment on the American Centrifuge Project in terms of the funding concerns or visibility that you have on that project. I realize your ramp visibility is limited but are there any broader macro concerns about funding for that project that you could comment.

David Bergers

I’ve always been a little concerned about the funding for it. I’d feel a lot better if there was support from Department of Energy and are some sort of a government backing for it and I’m not really aware of what the funding status for the program is Al, sorry to say.

Al Kaschalk - Wedbush Morgan

Okay. Secondly, on the wind business, I guess this is certainly a vote of confidence from what you’re seeing but the double digit growth was certainly a surprise for me in 2009. Could you comment or add some additional color on the degree of confidence you have there at greater than 10% because I think you said double-digits

David Bergers

Yes, double-digits now goes all the way down to 10%. I think we said our worst growth here was 15% or 16% on a constant dollar. I don’t know about constant dollar, but on a current dollar, we’ve averaged well over 15% over the last five years. Of course we’re on a bigger basis now, so that the percentages are now harder to get.

I am concerned about credit availability, and what it might do to wind. There clearly are some signs of softening, but from a frantic pace. I mean, there were many who were projecting that if there weren’t capacity constraints that turbine the megawatt installation pace could be in the 30% to 40% rate. So my hope is that if it slows down, if it has cancellations that it will drop to some nice teen or 20% rate. I see signs like a couple of third-party blade makers who are indicating some softening.

Third-party blade makers typically would be where excess capacity is achieved, and work hopefully would then instead be brought in-house, so where are customers would use our materials. The two things that really go against us just to be clear are the cost of capital is about 70% of the cost of wind energy, 70%. Whereas in fossil fuel plants, obviously fuel is the huge variable, so fuels drop dramatically.

Will it stay there, I doubt it. Fuel has dropped dramatically and cost of capital has gone up dramatically. So that sort of turned the wind equation upside down temporarily at least. On the other hand, renewable energy pressures interest in climate change, government assistance, jobs, all are going in the favor of winds. In December, the EU parliament passed a law that commits the EU Community to 20% renewable energy by 2020. And that’s not just electricity, that’s total energy. Each EU country has now signed up to a national legally binding renewables target.

The EU Directive also tackles obstacles related to new power lines, and transmission and distribution systems operators must give priority or guarantee access for renewable energy. Those are all very good signs for the long-term, I’m just not exactly sure whether it’ll have an impact in 2009. On the U.S. clearly there are some grid capacity issues with a frantic pace of installations in the last year.

T. Boone Pickens has withdrawn his big turn the world to windmill projects. On the other hand, Wal-Mart has got a goal to get a 100% of its electricity from renewables and is negotiating with utilities for some pretty big deliveries going forward. In China, in November, there was a significant finance package of various wind related subsidies. So I feel great about the long-term trends, I’m a little bit concerned about the short-term impact of credit markets.

Al Kaschalk - Wedbush Morgan

I certainly appreciate the detail, is there a way to frame the double-digit growth with pending, and a little ahead on 99 on the high, a little bit higher than what you’re seeing. Because it seems to me Dave that the shorter-term in the next six to nine months that this business could be working off of backlog and the new order book may not be so strong for the back half of the year and into 2010. Having said that I understand there is also some things that you come through the government in terms of subsidy and economic stimulus that could help out here?

David Berges

I don’t want to get too specific because actually I didn’t look this morning at the number ,this year was in the high teens and I’d be thrilled if it were that high but I would expect it to be inside that.

Al Kaschalk - Wedbush Morgan

Great. Thank you very much.

Operator

And we’ll take our next question from Mr. Steve Levinson from Stifel Nicolaus. Please go ahead, sir.

Stephen Levinson - Stifel Nicolaus

Thanks. Good morning everybody.

David Berges

Hello, Steve. Hi

Stephen Levinson - Stifel Nicolaus

Just to follow on this wind situation. The credit issues, financing issues that you were talking about, are you really relating this both to U.S. and European and Asian programs or is that mostly U.S.?

David Berges

I would say, those places that have more government assisted is less of an issue with those places that are little more free market based, it’s probably a greater issue. I’m not really certain of the funding in Asian markets, clearly the U.S. is worrisome, so I assume there are other parts of the world that are constrained by credit markets.

Stephen Levinson - Stifel Nicolaus

Okay thanks. And, in terms of where you’re operating, as a percentage of capacity. China, we know is new, but do you think you’ll be sold out once you get to through the year and the European plan?

David Berges

It’s both plans, both Colorado and China are designed with very close collaboration with our customers there. In the case of wind, our customers setup plants first and we followed. So they will hopefully be utilized a little more quickly and a little more fully than our satellite prepreg plants in Europe. Satellite prepreg plants for carbon in Europe are sort of the opposite. We’ve build them in advance of the program, the A350, and advance of the ramp-up as a part of getting qualified, helping us win the program and so forth. So in one case, we’re chasing demand and in the other we’ve build it, and hope that they come.

Stephen Levinson - Stifel Nicolaus

Okay, thanks. Are you getting anymore interest from other manufacturers who are not yet customers as turbine sizes get bigger and blade problems had been cropping up?

David Berges

We have activities with quite a number of turbine makers, but the vast majority of our sales are on the two that you are aware of, Vestas and Gamesa.

Stephen Levinson - Stifel Nicolaus

Okay, thanks. And just back to commercial aerospace, have you heard any updates from airbus, I know there are some people saying the A330 line is going to go from 8 to 10, and then their airbus has been saying we’re considering going 8 to 10. And how might that help you, if it does go up that too per month?

David Berges

Well, bigger planes are always better, almost always better, old 747 being the exception. Bigger planes are always better and, and awful lot of the talk of vulnerability of backlog seems to be to be around a 737 and A320, which are less worrisome to us. So, if the A330 steps up, that would be good, I assume that the A340 prospects don’t look as good, and that’d be an offset. This sort of gets back to what I was saying about A400M or other military programs, the delay of the 787 has increased artificially maybe the demand for A330s and 777s that take on that capacity.

Stephen Levinson - Stifel Nicolaus

Okay, and I’m sorry, one other one back on wind. What you’re hearing on Obama initiatives, do you think that will alleviate any of the financing issues or drive people to build more?

David Berges

Well, I see a lot of different people speculating on what’s going to happen, and of course congress has got to make thing happen too, not just the executive office. They all sounds favorable though for wind and other renewables. So I like what I hear with respect to how it’ll impact Hexcel. I actually would expect that both with the credit markets and the near death yet again of the production tax credit that we’d likely see, a cycle of short-term decline in installations like we have every other time that we went up to the 11th hour on the production tax credit. You always had this surge of people trying to install to get under the wire and then a little bit of a lull as the PTC is renewed and people start to reorder for their next traunch. So I’d be surprised if the first half of 2009 on an installation basis is anywhere as near a strong as the incredible 2008, 7 and 6 that we saw but, but I do think that it will come back pretty significantly, particularly with this administration.

Stephen Levinson - Stifel Nicolaus

Thanks very much.

Operator

And we’d take our next question from Mr. Karl Oehlschlaeger from Macquarie Securities. Please go ahead, sir.

Karl Oehlschlaeger - Macquarie Securities

Yes, thank you. Talking about the wind business a little bit again, in commercial aerospace you talked about the six month lead time, and there’s the back this backlogs and to a certain extend, at least for the first half of the year, you got a really good sense of what’s going to happen. Can you talk about that situation on the wind side? Is it a similar six-month lead time where you know the first six months of the year, you have a pretty good idea what your rates are going to be, and then the question mark is really the back of the year.

David Berges

We have pretty good visibility, no where as near as good as aerospace up until current market conditions. It’s also very high velocity business and as you recall our materials need to be stored in freezers. So there is not any kind of inventory built. So our customers have been shipping it at pretty frantic rate in recent years and if they have any kind of a problem like with the supply of a gearbox or a bearing or capacity constraints, we sort of have an immediate correction.

So while we have good visibility to what the demand should be and what the projections are. We know how many blade molds our customers have and how quickly they can turn a blade in those molds. So we know what the pace should be and that’s what we sort of plan on. If they have difficulties or problems we can have a pretty short snap back on delivery potential, not unlike an unexpected strike at Boeing. But on the other hand on aircraft dropping line rate and as I said after September 11, it wasn’t until nine months later that the actual build rates declined at Boeing. So there is definitely a higher beta in wind.

Karl Oehlschlaeger - Macquarie Securities

So thanks. And then looking at some kind of quarterly trends, how much of an impact, you talked about production rates at Boeing sort of not recovering until sort of February, how big of an impact will we see for you guys in the first quarter? And so what does that kind of mean in terms of how we should think about the quarterly trend and sort of kind of EPS? Are we going expect Q1 to be down a little bit and then up a bit in second and third quarter or there is uncertainty in the second half of the year?

David Berges

I didn’t give EPS guidance of any substance, but did you want monthly or quarterly, okay. Let me not answer that by giving you just a little color. Commercial aerospace first half second half I think are sort of the things to keep an eye on. If you look at the first half of 2008, for some unkown reason the first half of each of the last four years new programs have been strong in the first half and weak in the second half. Coincidence, it’s not seasonality but [inaudible] really delayed, things that kind of happen as the 787.

For a couple of years we talked about the first half new programs being about 10% of our commercial aerospace sales and then second half being about 5%. In 2008 the first half were about 15% of our commercial aerospace sales and about 10% in the second half, so first half second half thing that went on. So I call that a little bit of a hill to climb in the first half from a comparison basis if you believe that the new programs aren’t going to have a significant step up this half.

On legacy programs, I would expect them to be sort of similar to last year in the first half and then the big question mark is what happens in the second half. And in the case of Boeing we obviously have easier comps because of the Boeing strike. New programs hopefully do start to gain contractions though we haven’t planned on them.

On the other hand 2010 is an unknown and by summer we all should have pretty good indication of what Boeing and Airbus are saying about 2010 and then we’d be able to get a good look at the second half. The other aerospace though I remember is $200 million in sales and I do expect that to be down throughout the year. Did I not answer that question well?

Karl Oehlschlaeger - Macquarie Securities

No, that was great actually. In defense, maybe you’ve spoken about this before but could we get a sense if possible what sort of the ship set values would be on the JSF versus like the F-22?

David Berges

All those big programs that I described to you earlier are in the neighborhood of $1 million or so per each of them.

Karl Oehlschlaeger - Macquarie Securities

Right. Okay. Well, it’s great. Thank you.

David Berges

Sure.

Operator

And we will take our next question from Cristina Fernandez with UBS. Please go ahead.

Cristina Fernandez – UBS

Hi, good morning.

David Berges

Good morning Christina.

Christina Fernandez - UBS

Hi. I wanted to follow-up on the question on the new aircraft programs, at least directionally is there any more color you can give us on A380, 787 as we progress through the year. I mean are you expecting one of them to be up another down or both flat or how should we think about those two programs specific.

David Berges

I sort of lump them all together. Its just really hard to tie down exactly with what is going to happen, we have so many Tier one, Tier two, Tier three players that were shipping to and some of the materials that we shipped are used on multiple programs. So its really pretty hard for us to define, so I cant give you much detail on it because I don’t even know it that well. The A380 I really had hoped would start to a climb out of its doldrums, we had some signs of movement this year, but if you follow the trade press Airbus has backed off twice now on how many they expect to build next year. We generally have probably shipped materials for much of what is planning to be shipped next year and so we are sort of looking to what the builds are for 2010 that will start to give us some significant pickup. The 787 sort of similar with a numbers of delays. The most recent ones are sort of just my impression is they kind of put the build rate ramp up out past the current window of 2009. So just internally from a planning perspective, we just said lets not count on that to make our year and lets get our cost inline to deal with a unexciting year on new programs and if they happen to come in, we will see it as upside.

Christina Fernandez - UBS

Thanks. And then just a quick one for Wayne. With regard to pension, I know you terminated your U.S pension plans but you have a little bit of exposure to the European plans. How much is there going to be an impact at all in 2009?

Wayne Pensky

Yes, Christina, our biggest pension plan is in the UK and their returns this year were not nearly as bad as a lot of what you hear about in the U.S but still were bad. But at the end of the day we are probably expecting pension expenses here to just be up a couple of million dollars. So it’s not a huge overall number.

Christina Fernandez - UBS

Okay and does this flow through your composite materials segement,

Wayne Pensky

Yes, correct. That’s where it will be.

Christina Fernandez - UBS

Okay. Thank you.

Operator

And we will take our next question from Mike Sison with KeyBanc. Please go ahead sir.

Mike Sison - KeyBanc

Hey good morning guys, nice quarter.

David Berges

Hi Mike.

Mike Sison - KeyBanc

If 2010 build rates mirror 2003, 2004 somewhere around 600, could you maybe remind us how your position now versus you were then and maybe generally speaking how would you sort of manage the second half of the year in the event that bearish forecasts come in. That’s not my forecast, just sort of thinking about what the down forecast could be.

David Berges

You are going to have to first pick me up off the floor year, 600, come on? We would have to take a hard look at a lot of what we are doing to see what we could do to reduce cost, after September 11th we took off over 30% of our headcount, a tremendous amount of cash fixed costs. I don’t think we have that left to give and of course the outlook to me anyhow, the longer-term outlook looks awfully darn bright where as in 2002 we did know if things would come back. So to a little different situation, I cant say that if in June they announced that 2010 was going to be 600 airplanes, that we would be able to completely align this company for that kind of a drop, but I see no indications that we are going to have something like that happen.

Mike Sison - KeyBanc

Good. In terms of the industrial segment, wind being up high teens in the fourth quarter implies that the non-wind stuff was down high teens. Do you see any improvement there heading into the first quarter or sort of does that business remain pretty week as we head into on the first half of the year.

David Berges

Well I think we said that the other industrial, the non-wind industrials maybe have found bottom yet again. If you factor in that the American Centrifuge Project would be in that category. So I think any further decline in that sub-market would likely be offset by American Centrifuge Project , or at least so for the year.

Mike Sison – KeyBanc

Okay. Then last question, when you think about these facilities, that started with a negative impact in gross margin in 2008, gets little bit better in 2009, how close will you be at the end of the year in terms of getting that profitability closer to the average of your other facilities?

David Berges

I wouldn’t think that all of them combined are going to be at the average of the other facilities. Some, a couple of them might be because there will be at pretty good utilization rates, but in particular those satellite facilities, the satellites prepreg facilities in Germany and France are designed across the street from locations that are going to be big users for A350. They will be making materials for other products as well, but the A380 and A350 are the principal purposes for those facilities, and until they get two or three prepreg clients each in those facilities, they will be a bit of a drag.

Mike Sison – KeyBanc

Okay, great, thank you.

David Berges

Sure.

Operator

And we’d take our final question of the day from Mr. Michael Lew of ThinkEquity. Please go ahead, sir.

Michael Lew - ThinkEquity

Alright, thank you.

David Berges

Good morning.

Michael Lew - ThinkEquity

Good morning. With regard to the outlook you provided, does it incorporate a build rate decline for Boeing and Airbus? You’ve mentioned uncertainly in the back half of the year, does it incorporate the legacy softnss you’ve indicated or talked about?

David Berges

I would call it less a forecast than what our planning assumptions have been with respect to aligning our costs in our current business. So, I wouldn’t say that that flat assumption is exactly what we have in mind. As usual we can only repeat what public statements have come out of Boeing and Airbus, and we are privy to some internal documents, but even those are not fully fleshed out for 2010. So, I’ll put the second half still firmly in the question mark category.

Michael Lew - ThinkEquity

Okay. And, with regards to the A350 do you have a sense of timing as to when the secondary structure awards will be handed out, do you believe this could occur this year, Dave?

David Berges

I think bits and pieces and gradual design progress will sort of have a continuous and steady movement between now and three years from now for all kinds of pieces and parts and materials. They’ll all be interesting but they’ll not be anywhere as near as substantial as what we already declared in the primary structure of prepreg.

Michael Lew - ThinkEquity

Okay. And also with regards to another question on the wind business, you had mentioned you are engaged in discussions with customers that could shift over to the fiberglass prepreg technology. I mean how far along have progressed in negotiations, do you believe you could add another customer engagement this year?

David Berges

Well, we have activities with the customers, and we’re shipping materials to customers, a big changeover from infusion technology to prepreg technology by one of the other major players in this year is unlikely I’d say.

Michael Lew - ThinkEquity

Okay. And also on the competitive landscape, you’ve indicated some of the third party blade makers have indicated softening, are you experiencing increased competitive pressures, let’s say from Garrett?

David Berges

I think we’ve always had good competitive pressures from them, and I’d expect them to continue, I don’t know of anything that’s dramatically changed.

Michael Lew - ThinkEquity

Okay, thank you.

David Berges

Sure.

Operator

And that does conclude today’s question and answer session as well as today’s conference call. We appreciate your attendance, and have a wonderful day.

David Berges

Thanks very much.

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Source: Hexcel Q4 2008 Earnings Call Transcript

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