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Hexcel Corporation (HXL)

Q1 2009 Earnings Call Transcript

April 28, 2009 11:00 am ET

Executives

Wayne Pensky – SVP and CFO

Dave Berges – Chairman and CEO

Analysts

Howard Rubel – Jefferies & Co.

John McNulty – Credit Suisse First Boston

Cristina Fernandez – UBS

Al Kaschalk – Wedbush Morgan Securities

Noah Poponak – Goldman Sachs

Steve Levenson – Stifel Nicolaus

Nigel Coe – Deutsche Bank

Michael Lew – ThinkEquity

Operator

Good day, everyone, and welcome to this Hexcel first quarter 2009 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 Pensky

Thank you. Good morning, everyone. Welcome to Hexcel Corporation’s 2009 first quarter earnings conference call on April 28th, 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 2008 10-K and last night’s press release and the filing of the first quarter 10-Q.

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, Communications and Investor Relations Manager.

The purpose of the call is to review our 2009 first quarter 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 for some final comments.

Dave Berges

Thanks, Wayne. First quarter revenues were 10.8% lower than last year. About half of the reduction was due to the broad based decline in our commercial aerospace market, a bad thing, but half due to a dramatic strengthening of the dollar, a good thing. Space and defense and industrial sales were up nicely, but not enough to cover the aerospace decline.

Nevertheless, operational improvements along with good cost controls helped us generate record operating income of $39.9 million, 9.6% higher than last year’s first quarter. Net income of $23.4 million was also above last year.

As usual, let me fist cover the markets using constant dollars to describe sales trends. After years of a weakening dollar, there has been a major year-over-year swing that affects many of our numbers and ratios. The first quarter euro is on average 15% weaker than last year and the British pound is 27% weaker. For reference, our top line sales for the quarter of $307 million were 10.8% lower than last year’s reported, but down only 5.5% on a constant currency basis. So, the apparent sales decline of about $37 million was really $18 million in real terms. It’s important to note that if these rates stay as they are the second quarter exchange swing will be even more, maybe $26 million.

Commercial aerospace were about $154 million for the quarter, down about 16% in constant dollars from last year. While there have been few near term aircraft build rate changes announced by large OEMs there is clear evidence of across the board management of inventories by all of the Tier 1 and Tier 2 customers that we serve. We also felt the lingering inventory correction effects from the Boeing strike that spilled over into the first quarter as many of the Boeing supply chain only slowed their production through the strike.

Beyond Boeing and Airbus, our other aerospace sub-segment, which represents 25% to 30% of our commercial aero sales, was aided a bit by some non-recurring engineering and tool sales, but this sub-segment includes sales to the regional and business jet markets, which are under particular stress. We expect further declines over the course of the year.

Finally, the 787 program delay hurt our year-over-year comparisons we have begun to record some strong sales in the first half of 2008 for the program ramp up then it stalled after the delays were announced in April 2008. With the first 787 expected in June, we hope to be back on the growth path in the second half for new program sales.

Sales to space and defense markets were $77.3 million for the quarter, up almost 8% in constant currency, in line with our traditional growth rates in this area. Sales to rotocraft programs – let me include the V-22 in this category – constituted over a half of the space and defense sales this quarter and continued to be the growth driver in this market.

Sales for our industrial markets of $76 million were up nearly 10% versus the first quarter of last year on a constant currency basis though the as reported sales were down 3% due to the strength of the dollar. Glass prepreg sales for wind turbine blades were predominantly in euros and once adjusted for FX grew at double digit rates again this quarter. Vestas reported on their quarter last night and indicates continued strong demand, but cautioned of concerns about project funding due to credit markets. They continue to expect a year of double digit sales growth.

Sales to the rest of industrial markets were flat year-on-year, but up more than 10% sequentially from the fourth quarter levels. As you would expect, sales to auto and recreation sub-markets were very weak, but they were offset by growth due to the American Centrifuge Project and our new HexTOOL product range.

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

Wayne Pensky

Yes, thanks, Dave. Gross margin of about $77 million for the quarter was 25.1% of sales, an increase from the 23.3% gross margin for the first quarter of 2008 and significantly better than the 21.4% for the fourth quarter of 2008. Improved product mix, execution of factory productivity initiatives, incremental improvements at our new European facilities, a stronger dollar along with lower commodity and freight cost all contributed to gains despite the lower sales volumes.

The stronger dollar net of our foreign exchange hedges contributed about 75 basis points to the gain at the gross margin line and about 100 basis points to the operating income margin percentages.

Selling, general, and administrative expenses remained well controlled and they were down $2.6 million or 8.2% to $29.3 million for the quarter, helped by the weaker euro and pound. In constant currency, the SG&A costs were down about 2%.

The strong gross margin and the good control of all of our expenses resulted in operating income of 13% of sales. This was the first time in more than 10 years that Hexcel has reached the 13% operating income.

As we previously disclosed, we have put a concerted effort in the tax planning over the past year attempting to better align our structure with our view of the future. Our effective tax rate for the quarter was 32.5%. We expect this to be in the range of our new underlying run rate for the rest of the year. After excluding one-time items, last year’s effective rate was 38.5% for the quarter. Compared to last year, this year’s lower rate added about $0.02 to our earning.

The net debt increased by $28 million in the quarter to $372 million. The bid driver in the increase was a $35 million increase in accounts receivable as is typical for the first quarter due primarily seasonally higher sales in February and March as compared to November and December. Our past due receivables were lower than year-end and our overall aging has improved since then.

We ended the quarter with about $27 million in cash on hand and we had no amounts outstanding under our $125 million revolver facility. After considering the outstanding letters of credit, we had about $139 million of cash and available borrowings at the end of the quarter. We have begun discussions with our lenders and expect to either extend or replace the Senior Secured Credit facility well before the March 1st, 2010 expiration of the revolver portion of the facility. Based on our current outlook of interest rates, it’s obvious that any refinancing action we take will result in higher cost going forward.

While Dave has told you the effects of foreign exchange on our sales, let me once again remind you the role currency plays in our operating income. 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 exposures hedged at rates comparable to our 2008 hedged rates though those hedge rates vary by quarter. Remember, strong dollar helps us, so if the dollar stays where it is currently it would provide a small tailwind compared to 2008 on the 25% portion that’s unhedged.

Roughly every 5% strengthening of the dollar for the full year of 2009 would add about $1 million of operating income, but reduce our sales by about $24 million. Thus this creates an exaggerated improvement in our margin percentages. The sales exposure is primarily in euros, but we do have significant costs and working capital in both euro and British pounds, which can make comparing year-over-year changes for individual line items challenging.

Now, let me turn the call back to Dave for some final comments.

Dave Berges

Thanks, Wayne. We feel great about our performance this quarter, but I know many of you are more interested in our sales outlook. Unfortunately, we still have very little visibility beyond a couple of quarters and we don’t plan to handicap with the global recession, credit markets, or swine flu will do to the remainder of the year much less declare what our customers are planning when they haven’t yet disclosed themselves.

What I can tell you is that we have been and will continue to take actions to respond. As indicated by our first quarter results, we’ve already lowered our cost structure and improved operational performance enough to allow us to weather a constant dollar decline of 5% that still hit last year’s EPS performance. We would also expect improved cash flow if sales decline as the need for working capital lessens with weaker demand.

Weaker outlook and the availability of carbon fibers also allowed us to adjust our capital spending profile and we currently foresee less than $100 million of CapEx this year and less than $125 million next year. As in the past, we are focused on managing things within our power to control and encourage that we, unlike many, can look forward to the coming pay-off from the relentless transition to composite-intensive aircraft and the global push for clean energy from wind and uranium.

Now, we’ll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) And we’ll take our first question from Howard Rubel.

Howard Rubel – Jefferies & Co.

Thank you. Two questions, one is with the lower capital spending and with somewhat improved receivables turn, Wayne, how significant will your free cash flow be this year, I mean could it be $20 million to $25 million?

Wayne Pensky

Yes, Howard, we’ve said we intend to be free cash flow positive and we are sticking to that. How big that number will be I think will just depend on the amount of sales near the – in the fourth quarter. That will probably be the bigger driver of everything.

Dave Berges

Our main point, Howard, is that if sales get worse than people are expecting, cash should get better.

Howard Rubel – Jefferies & Co.

The model works!

Dave Berges

Pardon me, yes?

Howard Rubel – Jefferies & Co.

The model works!

Dave Berges

Right.

Howard Rubel – Jefferies & Co.

I mean it does what it’s supposed to do as opposed to getting stuck with something. You know I appreciate that. And the second thing is in terms of new products and in terms of the F-35, could you – and sort of what you are going to do with even the capacity that you’ve added? Could you address some of the markets that that’s going into and how this will offset maybe some weakness in other markets, Dave?

Dave Berges

Well, let me talk about a couple of pieces of capacity. First, wind energy capacity coming on late in the year in Colorado and China are to address our customers making blades there. So that sort of stays independent assuming those projections from our customers remain true. And they are really relevant to any of the worry that goes on now in commercial aerospace markets.

In military programs we’ve got good visibility and almost have for what the long term prospects look like for our carbon fiber and we’ve always managed and monitored that very closely as have our customers and as has the U.S. government.

The main CapEx expansion, as you all know, has been for our future outlook on the A-350. In the case of prepreg, we’ve put plants up in Europe. Those plants are up, qualified and running, supplying developmental materials to the A-350 now. I am sure that as we go through the development phases of the A-350 there will be stops and starts of that capacity just because that’s the nature of a new airplane program. Longer term, each of those plants will have additional prepreg capacity and be great contributors.

The principal CapEx, of course, is carbon fiber. Carbon fiber has gone from severe shortage a couple of years ago that was stifling many, many composite markets to now what is clearly a surplus. It started with the delay of the 787 and of course the global slowdown in other markets has freed up even more particularly in the industrial range of carbon fiber. Ours was specifically designed to position us for the USEC program, the American Centrifuge Project, the A-350, and the known builds for F-35 and other such programs. So, we still expect to have good utilization. We expect that the margins will continue to be aided – our overall margin will continue to be aided by the richness of fiber mix. Fiber as we’ve long said has a higher gross margin as it needs to cover the tremendous capital that’s required.

Howard, are you still there or are you still trying to imagine if I came anywhere as close to your question?

Operator, I think we lost Mr. Rubel.

Operator

Okay, one moment. I believe his line is still—

Dave Berges

Why don’t you go to the next caller and Howard will dive back in I am sure.

Operator

Okay, we will go to John McNulty next.

John McNulty – Credit Suisse First Boston

Yes, good morning.

Dave Berges

Hi, John.

John McNulty – Credit Suisse First Boston

Just a couple of questions. With regard to the USEC business I know that that platform or that contract has ramped up at this point. Can you give us a clue as to how ramped up it is or what the contribution was into the industrial segment and how that should progress throughout the year if we’d kind of plateaued there or if it should pick up further?

Dave Berges

We’ve given the general guideline of $100 million over three years, right, Wayne?

Wayne Pensky

Right.

Dave Berges

Over three years?

Wayne Pensky

Yes correct.

Dave Berges

And so it started to ramp up and it’s probably getting close to what we would think to be the run rate of the fiber portion. There will likely be some prepreg portion further down the road that would be added to that. We would like to think that it’s going to be consistent going forward for two and a half years, but do keep an eye on the funding for USEC. They are working and getting close to funding the project and that’s an important part of our prospects there.

John McNulty – Credit Suisse First Boston

Okay. And then with the two wind plants, the China wind plant and the Colorado plants, I know one is ramping up and one is I guess working to get qualified right now. In terms of the costs that are tied to that is that something that’s holding the margins back at this point or is this something that would be kind of view as negligible and not really an impact one way or the other.

Dave Berges

Well, first remember we started last year talking about the incremental costs, fixed and start-up costs of new plants. So, if I could just drag you through the entire history, the first coming on line was our fiber plant in Spain. That really started to impact us from a cost standpoint last year in the first quarter and that is up and running in good shape now. So, it’s a contributor.

Then we have the two prepreg plants in Europe that started to impact us in the second and third quarter. Those are qualified and running, but as I said before those will be ‘on again, off again’ as we develop the A-350 platform. So those won't be contributors. They won't be big pains, but they really won't get up to average margins probably until they get to some serious volume out a year or two.

China is running probably didn’t quite have a full first quarter, but this is really close to a full quarter in the China plant, so it’s again – will contribute more when additional lines are added probably drags the average down a little bit, but it is a minor point.

And Colorado is just still being built and we hope to start qualification process in the latter part of the third quarter. I would say overall from – in this quarter and going forward for the next at least three quarters the year-over-year delta of new plants’ start-up cost will be improved.

John McNulty – Credit Suisse First Boston

Okay, great. And then just one last question. On the margins, the 13% certainly is a lot better than we’ve seen in the past despite having some pretty operating leverage. Beyond the raw materials costs being lower and the FX benefits, which I think you had highlighted on the call, is there anything specific that may be either one-time or a temporary blip that – where we shouldn’t be kind of thinking about this going forward as kind of a normal run rate in this raw materials and FX environment?

Dave Berges

I think there is a pretty broad mix of things that you need to think about some being may be temporary and some being more permanent. I think the main thing, kudos to operations on this part is that we’ve made a lot of improvements over last year as we needed to and as we expect to. We were running so much over capacity many of our operations last year. There was a lot of scrambling, excess over time, premium freight charges, extra setups. It was not pretty if you are an operations person last year. When you have growth, unexpected growth that’s beyond your capacity that can happen. You look to run close to capacity, but running beyond it efficiencies usually suffer.

So, we are getting way back under control. Have made a lot of good gains in the factory. I would expect those to continue at these run rates and then certainly what everyone is focused on now since we have very little ability to influence sales. I do remind you that first half, second half is typically very seasonal. If you go back over the years, you typically would find about two point differential first half to second half though there have been exceptions in periods of strong growth. So, if you factor in some normal seasonality I would say that we’d like to see a strong first half and both volume and seasonality might create some issues on the second half.

I do want to point out though the importance for those of you who have models of this FX, this swing of getting the sales right for FX or going to a constant sales number is pretty darn important if you are using margins. So, as we pointed out I think the operating margin benefit just from FX was 100 basis points. I would love to take credit for it, but last year we complained about it going the other way and so we can't take credit for it this way. So that 13% is really a 12% from operations.

The second quarter, the exchange rate is even more beneficial to us. That 100 basis points might move to 130 basis points. I don’t count that, but you need to when you are building your models and remember the real shift in exchange rates happened in the fourth quarter. So, third quarter might look a little bit like this with respect to exchange rate help to margins and the fourth quarter we return to parity if exchange rates stay where they are today.

John McNulty – Credit Suisse First Boston

Okay, great. Thanks for the details.

Operator

And we’ll take our next question from Cristina Fernandez with UBS.

Cristina Fernandez – UBS

Hi good morning.

Dave Berges

Good morning.

Cristina Fernandez – UBS

Of the declining commercial aerospace that was not related to the Boeing strike could you give us a little bit more color as to how much business is regional, what’s down and how of it was attributable to the inventory de-stocking at Airbus and Boeing?

Dave Berges

I don’t really have a good answer for you. It’s just sort of wide spread broad based. There is nothing that really jumps out. The only pieces we could pull out of the data and these are rough estimates is that the year-over-year delta from new programs, essentially 787, was about $10 million. And we think that the lingering effects of the strike specifically was about $10 million. And we get there pretty crudely. They were planning to ship a 100 more airplanes than they did last year. And our sales were down 40 and normally you would expect them to be down 50 on a 100 average airplanes. So, we estimate that the strike was maybe $10 million of the pain [ph] and the 787 was maybe 10 because of the slowdown. All the rest of it we just have to say is spread over all of the suppliers to those customers.

Cristina Fernandez – UBS

Okay. And then with relation to your guidance was the guidance you gave in January does that include this 32.5% tax rate or if – is that helping you offset the additional revenue decline you are seeing now? How can I bridge the guidance you gave in January versus now to help you still achieve (inaudible) EPS growth next year for the full year?

Dave Berges

Well first I will try once again to remind you that it wasn’t guidance in the first quarter nor do I have guidance today. We say we just don’t have enough visibility to what line rates are going to do our commercial aerospace part of our sales in the fourth quarter because 2010 build rates is what will drive that. What we said was we had planning assumptions to get our costs in line so that we could still have earnings growth even if we didn’t have top line sales. So, with that qualification, I will say we have been talking for some time about major efforts we’ve been doing to restructure our attack structure. And while I know a lot of you don’t count tax gains, I just finished writing a big IRS check and I had to consider that one day we might be calling these the good old days. A lot of hard work and some significant SG&A expense last year resulted in a refined global structure that will give us real cash savings going forward. And we had anticipated that for the majority of this year we’d have a better rate.

Cristina Fernandez – UBS

Okay. And then with – in the space and defense market, you mentioned then half of it is helicopters now. Can you give us more color as to how much is replacement blades versus content on new platforms? And then on the other 50% how much is military aircraft versus space structures versus other items?

Dave Berges

We have a broad range of coverage in what we call rotorcraft. On rotorcraft we include the V-22, which isn’t technically a helicopter, but it’s a very good program for us. And that one probably stands out amongst the others that’s in our top five or ten programs. Replacement blades, we wouldn’t know exactly because generally we are selling materials to our customers who are making helicopters or blades and we don’t particularly know what the replacement rates are. I would say that it’s a very small percentage would be my guess though it is probably one of the very few places in the entire repertoire of Hexcel sales that have anything to do with replacements. Almost everything we do is renew, build, so we don’t have the spares exposure that many of our aerospace peers have.

Military and commercial mix, again, many of these aircraft are the same design that is used in both categories and I don’t really know the answer. I would say that the vast majority – I would say certainly the majority are military based. I am looking at Wayne to see if he is agreeing, yes. So, I would say mostly military. And it’s – many of the customers and we have one that we pointed out last year some increased content or some value added on a couple of our blade programs where we are now helping to do some sub assemblies and in some cases even almost completed blades.

Cristina Fernandez – UBS

Thank you.

Operator

Next, we’ll go to Al Kaschalk with Wedbush Morgan.

Al Kaschalk – Wedbush Morgan Securities

Good morning guys.

Dave Berges

Hi, Al.

Al Kaschalk – Wedbush Morgan Securities

Dave, I wanted to try and press a little bit on this margin story and then I appreciate the comments about the operating up about 130 basis points if dollar stays where it’s at. Should we assume that’s off of the 13%, I mean how do we calibrate 12%-13% operating margin as a basis to adjust up or down given the trends that we are seeing? Because it appears that we are setting up for a back half of ’09 where volumes aren’t going to be as strong or you are just – you are anticipating that. I just want to understand a little bit better the leverage here in the model as we look now.

Dave Berges

Unfortunately, Al, it’s a little hard to predict. I would admit that the margins were better than I expected this quarter. The gains that have come in the factories that comparisons of year-over-year new start-ups, some what are probably temporary low level commodity input materials that benefited the quarter. Last year we got caught with some of those things such as acrylonitrile freight premium costs and some utilities while we have – most of our supplies match up contract wise with our customers we did get hurt last year and we talked about it on the call a couple of times. Those increased costs became a basis for negotiating as new contracts came – became due. So, in many cases we got some price increases and now with a temporary down draft in things like acrylonitrile and oil, which I am sure will be back shortly, we got a benefit. So, it’s a pretty complex model and I am sorry to say going down in sales typically is very hard not to have a punishment to the absolute margin.

Margin percentages, we work real hard to try and not to have those get hurt. You might recall that after September 11, sales went down. Commercial aerospace sales for us dropped 30%. We were able to expand our margins. Jim McNulty [ph], I heard last week, called this a once-in-a-life time slump while may be for my year-old grandson we’ve been through this before and not to say things haven’t changed or we’ve got this sort of latitude to take that kind of cost out this year. But that’s our desire and that’s our intent. We are going to try to do all we can do to respond to whatever happens without sacrificing our long term growth entitlement.

Al Kaschalk – Wedbush Morgan Securities

Well, will it be fair to say that this may be the high water mark for the year in terms of margins or is that a little bit too much of a reach at this moment?

Dave Berges

I don’t know. If you are counting – if you give us credit for FX, which of course we have nothing to do with, we get a help in the second quarter and the second quarter is usually a strong quarter for us. Last year’s sales in the second quarter were extremely strong. So, top line sales I think last year second quarter were 20% higher than this quarter that we just passed.

Al Kaschalk – Wedbush Morgan Securities

Was it just aerospace or–?

Wayne Pensky

No, it’s total.

Al Kaschalk – Wedbush Morgan Securities

Total.

Dave Berges

So, again, you have to adjust maybe $26 million out of there for FX difference, so the sales number is not likely to impress just like this first quarter didn’t, but I wouldn’t be surprise to se margins come in strong for another quarter because of the FX gains.

Al Kaschalk – Wedbush Morgan Securities

On the industrial side and specifically wind, you made the comment or referenced that you hope – may be said that if projections stay true or the customers’ projections stay true, can you comment on when you expect that update or do you have a time slot for an update or do you just plan to produce throughout the year based on–?

Dave Berges

I think wind as opposed to commercial aerospace has got a lot less visibility and things could change more quickly than aerospace. Typically, in commercial aerospace, not so much business jet, but in the big airplanes, the whole supply chain gets quite a bit of advance notice of a change. You’ve seen some announcements like the 777 declined from seven a month to five a month. It’s targeted for June of 2010. We don’t have that kind of advanced warning from wind energy customers. So, we just look for the press releases and the comments that they make publicly and then we try to monitor what’s going on at the plants where blades are made and we deliver materials. So, I am a little bit concerned of some of the comments in the release this morning about decreases in Denmark, which is a big shipping locations for us. Talk of some lay offs there. Part of it is because they are now going to make the blades in the U.S. and China. So, there is possible that there would some near terms disruptions in our supply chain, but longer term, if you get – if you look past a quarter or two, all the basics really look good. Government initiatives in the U.S. and Great Britain in particular have been a good news area.

So, I think unfortunately we are just going to have to monitor closely and respond quickly. The thing to remember is we are starting with a very high revenue growth history and so far most of the people who have lowered revenues have lowered them from very high numbers to nicely high numbers.

Al Kaschalk – Wedbush Morgan Securities

Finally, given the concerns on the outlook, do you have further cuts to make in terms of cost structure over head, personnel, if you – I know you made some since the summer of 2008, but where are you at in your thought process on the outlook for personnel cost?

Dave Berges

Well, we have made cuts and we’ll continue to review opportunities, but I think the big opportunities for us are on improved efficiencies. The fact that we know we have growth in the future makes Hexcel a little bit different than other businesses that are run where a downturn maybe looks semi-permanent like a U.S. auto market. So, we’ve got to be a little more judicious about what we do knowing what the future entails. I don’t worry because we really do have great opportunities for efficiencies and I think that the majority of what we’ll do to respond will be fine tuning and improving or refocusing a lot of our talent and skills into operational efficiency.

Al Kaschalk – Wedbush Morgan Securities

Thanks a lot and nice performance on the quarter.

Dave Berges

Thanks very much.

Operator

(Operator instructions) And next we’ll go to Noah Poponak with Goldman Sachs.

Noah Poponak – Goldman Sachs

Hi good morning.

Dave Berges

Good morning, Noah.

Noah Poponak – Goldman Sachs

Just following up on wind and you talked about Vestas having just reported, it looks like they are saying demand is still strong and growth can still be 20%, but the huge ‘if’ is financing, and I think they used the word crisis in there. And so I just wonder if you can may be tell us what your checks on the financing environment for these projects looks like?

Dave Berges

No, I don’t know. I am hoping that some of you guys in the industries that you are in will help us understand it. We sell to somebody like a Vestas or like a Mesa [ph] blade shop who then ships it to the turbine assembler and sometimes they have their whole – the whole field installation responsibility and sometimes are just shipping turbines and it can be anywhere in the world. It’s – we know what projects they have and who has won what, but the financing behind each of those projects is not something we’ve been able to get good visibility into.

Noah Poponak – Goldman Sachs

Okay. And then I wanted to ask you about China. There is plenty of discussion of it you know really breaking away from the rest of the world and economists taking up their GDP forecasts there and you guys clearly have exposure there, you are expanding capacity there. Are you able to quantify what percent of the total business ultimately ends up in China right now and maybe where you see that going in the next three years and just sort of how you are thinking about that part of the world?

Dave Berges

Are you talking about wind, specifically?

Noah Poponak – Goldman Sachs

I am talking about the total business, but if you want to talk specifics on wind as well.

Dave Berges

Well, let me just ask one more clarifying question. When you say China breaking away from the rest of the world, is it like the U.S. did recently or do you mean that they are going to break out of a slump first?

Noah Poponak – Goldman Sachs

Yes, I just mean the rest of the world in a huge recession with declining GDP and the forecast there for GDP to grow almost double digits.

Dave Berges

Yes, I think wind energy is going to be a good growth area because we are starting from almost nothing and how you balance that with what blades customers were shipping from Europe, I am not real clear. I think wind will grow there just as strongly as everywhere else in the world though there will be a lot more local competition. So, I don’t consider it a complete break out in our wind market. I think it will probably net out to be a similar growth rate as the rest of our wind markets. That’s just a guess.

I think the biggest benefit to recovery of China or any other big country that they can be a big driver or commercial aerospace recovery. We do almost nothing or probably nothing I hope nothing that ends up in military because of export restrictions. So commercial aerospace is probably the place where we’d see the best benefit from a recovery in China.

Noah Poponak – Goldman Sachs

Okay. And I will take one last shot at the margin question. You had said at the end last year that you’d expect the gross margin for this year to be between 07 and 08, it was a lot higher in the first quarter, you just touched on that seasonality you have. Should we still expect the full year to come in there or should we just expect the rest of the year to come in between 07 and 08?

Dave Berges

We didn’t actually project that last year. I believe you are referring to a question that I got on this call where someone sort of led to – or suggested that I was targeting 24% to 25% gross margin, which, I am embarrassed to say, I thought was way to high and said so on the call last quarter. Desperately seeking some answer give him, I suggested it should be between the 27% and 28% without having even looked at it. I think this year’s margin, if you don’t discount for the FX change will clearly be better because of the efficiency gains and the FX gain. I don’t have specific guidance on what the margin will be other than I would expect the first half will be stronger than second half as it has been many of the last ten years.

Noah Poponak – Goldman Sachs

Okay. Thanks a lot.

Dave Berges

Okay.

Operator

And we’ll take our next question from Steve Levenson with Stifel Nicolaus.

Steve Levenson – Stifel Nicolaus

Thank you. Good morning, Dave and Wayne.

Dave Berges

Hi, Steve.

Steve Levenson – Stifel Nicolaus

Vestas has said they are going to expand I guess to service Inner Mongolia. Is that something that you can do from your plant in China, is it from other plants, or you are going to have to build something else?

Dave Berges

The transportation costs of wind turbines is causing an awful lot of little plants being built in lots of parts of the world and I think you are going to see a lot more of that. I am hopeful that our principal operating base will be just one in each region though I don’t know for sure what the world will bring. We can ship our materials in a freezer truck. It’s a lot easier than shipping blades. So, I do not expect to follow every new facility that’s built by our customers.

Steve Levenson – Stifel Nicolaus

Okay, thanks. You were talking about surplus carbon fiber. I know you will probably continue to be a net purchaser but how did that change in the last quarter, how do you think it might be for the year and how does that impact margins?

Dave Berges

I don’t think the mix will shift dramatically. A lot of what we purchase we must because of qualifications. A lot of what we sell must be purchased from us because of qualifications, not entirely. Where we have started to apply our fiber to new programs like the A-350 and the USEC Centrifuge Project, it’s certainly enhancing our margins to the extent we have excess to aerospace demand. We sell into industrial markets or convert into prepregs for the industrial market. As there is a surplus on the market the pricing s lower, but it’s still an incremental gain for us. So, in general, we would expect now that the startup of the first lines is behind us and we are starting to see year-over-year growth in the use of our fiber that it will continue to contribute to our margin mix and expand our – it helps expand our margins albeit still a small part of what would be our sales should it all be sold on the open market.

Steve Levenson – Stifel Nicolaus

Okay. Thanks. Last one is with the winding down of F-22 and the beginning of F-35, how do you see that impacting the Company? Is there sort of a – is there a balance or are you are going to lose out on one first before the other picks up?

Dave Berges

Well, I don’t know what the timing will be of those, Steve. I see Secretary Gates calling for the end of the C17 and F-22 and perhaps that will happen, but my recollection is the same thing we said last year and may be the year before and Congress in the interest of jobs probably put it back in. So, I don’t spend a lot of time worrying about it until we see the order pattern change. The F-22 and C17 are both in our top ten important programs for us. Obviously the F-35 will be as things build up I am hopeful that you will see some sort of a gradual phase out if there is one and other things will take its place. Remember, our rotorcraft is more than half of the segment. So, the growth of rotorcraft, if you believe there will be some because of Afghanistan and so forth and replacement cycles could also cushion or even outweigh any decline in other programs.

Steve Levenson – Stifel Nicolaus

Great, thanks very much.

Operator

Next, we’ll go to Nigel Coe with Deutsche Bank.

Nigel Coe – Deutsche Bank

Hi, good morning.

Dave Berges

Good morning, Nigel.

Nigel Coe – Deutsche Bank

Just a quick one here. Just going back to tax rate quickly, you seem to indicate that 32.5% was good for the 2009, is that sustainable beyond 2010 – 2009?

Wayne Pensky

Yes, Nigel, it’s Wayne here. We believe it is sustainable. We’ll always continue to look for improvements and try to find ways to lower it, but assuming tax rates in the countries don’t change, we would hope and hold that this rate are lower.

Nigel Coe – Deutsche Bank

Okay. And then in similar vein on FX, some of your hedges roll off in 2010. I believe you are 35% hedged for 2010. Does that mean that you get similar benefits in 2010 on the margin that you saw this year?

Wayne Pensky

Yes, well hopefully actually 2010 will be a little bit – if freights hold where they are today, 2010 will hopefully end up being a little bit better. We roll our hedges in up to two and a half years in advance, so we actually have a little bit in 2011 and part of 2010 as we roll from I think we are at 40% today as we will probably end the year being 75% hedged for 2010. So, as we roll our new hedges we will at – for at today’s rates that’s better than the rates we are at today. So – or better than the hedge rates today. So, hopefully we’ll get a little bit improvements.

Nigel Coe – Deutsche Bank

So, just to clarify, if we stop the clock today, then you get a point of margin benefit in 2010 as 2009 from FX?

Wayne Pensky

Yes, correct, if you stopped it today.

Nigel Coe – Deutsche Bank

Okay. And then just coming back to this margin question, I know it’s been (inaudible) but in terms of seasonality 1Q, first half is certainly stronger than second half. 1Q tends to be the strongest at a gross margin level. Is it – is that just utilization of the plants so depending [ph] on the sales mix sites [ph] that causes that phenomenon.

Dave Berges

My view of seasonality is it’s the first half more than the – the first half.

Nigel Coe – Deutsche Bank

Okay.

Dave Berges

And it’s principally days worked. We have a – half of our sales roughly are in Europe and there is a pretty significant holiday period in August, partly in July. There is usually a ramp up before then to try to get schedules out the door and then you have in the States Thanksgiving and then you have the Christmas holidays, end of the year holidays, and some inventory corrections. So, just looking over the years, there are a couple of exceptions, but I always pay attention to it, and it’s – it’s just ranges in the neighborhood of two points of both gross and operating margin, first half to second half. So, I just remind people of that.

Nigel Coe – Deutsche Bank

Okay. And then just finally, the China and Colorado glass fiber prepreg for wind, when those two facilities are at full capacity? What sort of revenue run rate do you expect?

Dave Berges

I don’t think we’ll give something out like that and I also wouldn’t know how to define full capacity because each of the new prepreg satellite plants, those two plus the two in Germany and France are really intended as the new platform, the new footprints for that region. So, in the case of the A-350 those plants will – are designed to allow us add prepreg lines in a series or in parallel. The same can be true of the other plants. So, full capacity is – full capacity of the existing lines is about the only way we can look at it and we haven’t given out any numbers on that.

Nigel Coe – Deutsche Bank

Okay. Fair enough. Thanks a lot.

Operator

Next, we’ll go to Michael Lew with ThinkEquity

Michael Lew – ThinkEquity

Hi. Thank you for taking my question.

Dave Berges

Good morning, Michael.

Michael Lew – ThinkEquity

Good morning. In the past you’ve mentioned that you earn about roughly about half million per plane for the non-composite intensive aircraft. Given that Boeing and Airbus are experiencing pricing pressures, which has impacted margins, wanted to know how often do you negotiate your supply contracts? (inaudible) reviewed and when is the next time they will be reviewed?

Dave Berges

Different customers have different durations and they don’t always repeat with the same duration. We don’t disclose how long those contracts are or when they are coming due other than occasionally like with – (inaudible) the A-350, which was an independent contract. But they both, Boeing and Airbus have multi-year contracts and once negotiated whatever the terms of that contract are to my experience honored through the duration.

Michael Lew – ThinkEquity

Okay. And also with regards to the wind business, do you see any potential acceleration in that business for the year and are you currently engaged in any later stage discussions with potential new customers?

Dave Berges

I would say no to the second question. We are working with a number of customers on developments for next generation blades. However, the pace of growth as I think I mentioned on the call was such that most have stayed with their traditional concepts and designs and materials. That’s good news in the case of our customers and not as good news in the case of penetrating new customers. Do I expect a surge? It’s been nothing but surges since I came and with that sort of view point, I would say I would expect less of a surge is more likely than a surge at this stage just because of credit markets and the ability to finance. The longer people have difficulty getting access to capital, the more I worry about a slowdown in the growth rate. The sooner it comes back, the sooner I think we’ll start talking about surges again.

Michael Lew – ThinkEquity

Okay, great. Thank you.

Operator

And that now concludes today’s conference. We thank you for your participation.

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Source: Hexcel Corporation Q1 2009 Earnings Call Transcript
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