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Hexcel Corporation (NYSE:HXL)

Q4 2009 Earnings Call Transcript

January 28, 2010 12:00 pm ET

Executives

Wayne Pensky – SVP and CFO

Dave Berges – Chairman and CEO

Michael Bacal – Communications & IR Manager.

Analysts

Howard Rubel – Jefferies & Company

John McNulty – Credit Suisse

Steve Levenson – Stifel Nicolaus

Mike Sison – KeyBanc

Nigel Coe – Deutsche Bank

Al Kaschalk – Wedbush Securities

Lucy Guo – Macquarie Research

Avinash Kant – DA Davidson & Company

Operator

Good day, everyone and welcome to this Hexcel Corporation fourth quarter 2009 earnings release conference call. As a reminder, today’s conference is being recorded. For opening remarks and introductions, I would like to turn the call over to Wayne Pensky, Chief Financial Officer. Please go ahead, sir.

Wayne Pensky

Great, thank you. Good day, everyone. Welcome to Hexcel Corporation’s 2009 fourth quarter and full year earnings conference call on January 28, 2010. 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.

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

With me today are Dave Berges, Hexcel’s Chairman and CEO, and Michael Bacal, our Communications and Investors Relations Manager. The purpose of the call is to review our 2009 fourth quarter and full year results detailed in our press release issued yesterday.

First, Dave will cover the markets, then I will cover the financials, and Dave will provide our outlook and then we'll turn over to questions.

Dave Berges

Thanks, Wayne. Fourth quarter revenues of $267 million were down about 8% from 2008, 12% lower if you just to a constant currency comparison, somewhat better than the full year of 14% FX adjusted decline.

Well, it’s true that last year’s Boeing strike made for an easier comparison, sales were up about 3% sequentially from the third quarter, as we saw signs of life in the commercial aerospace market, our biggest. After adjusting for the previously disclosed legal settlement, operating margins of 8.3% were better than the third quarter, but below last year’s operation – as operational improvements did not fully recover the impact of the sales decline. I’ll have the emphasis in all elements of cash, resulted in another strong quarter of almost $17 million of free cash flow. For the year, that makes it 74 million of 153 million improvement over free cash in 2008.

Now, let me cover the markets using constant dollars to describe sales trends. Remember in 2008, the dollar was extremely weak for the first three quarters than strengthened significantly at the end of the year. In 2009, it has steadily weakened. In the fourth quarter for the first time in the year, the dollar is again weaker than the prior year, exaggerating our sales by compressing our operating income. Commercial aerospace sales were about $137 million for the quarter, down 7.2% from last year’s strike affected sales.

Well, it’s difficult to gauge the exact impact of last year’s strike in our Boeing’s sales, it is worth noting that we had a 10% sequential revenue growth for the quarter for Boeing programs. Sales to Airbus also had modest sequential growth, and while they were down almost 25% for the year, the fourth quarter moderated to a 17% from the comparable period in 2008. Our regional and business jet submarkets and sales remained at the low levels of the prior two quarters and were down more than 40% year-on-year. This submarket now represents about 20% of our commercial aerospace sales and continues to run at about the $100 million run rate that had become evident after the first quarter of 2009.

Sales for new Airbus and Boeing programs A380, 787, 747-8 and A350 were up for the quarter as compared to both the prior year and the third quarter. These new programs made up more than 15% of our commercial aerospace sales for the first time since we began tracking this ratio.

Sales to space and defense markets were $73 million for the quarter, down 7% on a constant currency basis. The end of the F22 program has began to impact us, but were other gains and losses in the period. For the full year, space and defense sales were just higher than 2008 on a constant currency basis.

In industrial markets, while the quarter’s as reported sales of $56.5 million were down 18%, the FX adjusted drop was almost 26% for the quarter versus 15% for the year. Sadly, our sales to wind markets after a five year run with compound annual growth over 30% fell victim to the global credit crisis and also ended the full year down 15% in constant currency despite a strong first quarter.

Now let me turn the call back to Wayne for some additional comments and then I will come back and talk about the outlook.

Wayne Pensky

Thanks, Dave. Gross margins of about $56 million for the quarter was 21.1% of sales, a slight decrease from the 21.4% gross margin for the fourth quarter 2008. However, the year-over-year exchange rate impact our gross margins by about 100 basis points, so after that adjustment we are 70 basis points higher than last year. As operational improvements, cost controls and staffing adjustments more than offset the impact of the significant sales decline. Gross margins from the third quarter to fourth quarter were up sequentially by about 80 basis points due to improved mix of sales, exchange rates having only a nominal impact.

For the full year the exchange rate impact was less pronounced despite the 16% sales decline, we expanded gross margins by 60 basis points to 22.4% for the year. Selling, general, administrative expenses for the fourth quarter were $26.8 million or $2.8 million higher than fourth quarter 2008. This was due to exchange rates and lower variable compensation expense in 2008. The full year is a better indicator of our run rate and those expenses were $5.7 million or about 5% lower than the full year 2008.

Research and technology cost were $7.5 million, about the same as the fourth quarter last year in constant currency. For the full year research and technology costs were $30.1 million or about 3% more than 2008 in constant currency.

So going into 2010, our average hedge rate for the year is slightly more favorable than our average hedge rate for 2009, and we are nearly 75% hedged of our estimated 2010 euros and British pound operating income exposure of about $100 million.

Effective tax rate for the fourth quarter was 31.7%; it was 28.4% for the year. After excluding onetime items for full year 2008 rate was about 38%.

So our 2009 rate reflects the benefits actions taken over the past few years and we expect our 2010 tax rate to be around 30% before discrete items.

In addition we are rewarded up to $8.1 million in New Clean Energy Manufacturing Tax Credits as part of the American Recovery and Reinvestment Act. The credit supplied on qualifying expenditures we have incurred back to February of 2009 at our new Colorado facility. We expect to record over $3 million of tax benefits in the first quarter of 2010 related to the qualifying expenditures that we've already made. But we don’t envision any further credits this year.

The total debt, net of cash stood at $282 million at the end of the quarter, down $15 million for the quarter and $61 million for the year. This is the lowest our net debt has been since 1996.

In addition, prudent reduction of capital spending we generated $35 million of cash from working capital for the year including $38 million from inventories and $32 million from accounts receivable.

In addition to working capital benefit of the reduced sales we also improved both our inventory and receivables on a day’s basis.

At December 31our $125 million revolver remained undrawn and we had a $110 million of cash on hand. This January we repaid $30 million on the term loan and even after that repayment our cash on hand and available borrowings under our revolver facility is still over $200 million.

Interest expense for the quarter was $6.3 million, higher than last year's $4.7 million in the same period. The difference was due to higher average borrowing costs and associated amortization deferred financing cost for the new credit facility refinanced in May of 2009.

The previously disclosed legal settlement of $7.5 million relating to ending the Gurit patent issue is recorded as other operating expense and is the only exclusion in our non-GAAP adjustment to operating income. Likewise, there is an after-tax income of about 6% -- $0.06 reflected in our adjusted earnings per share.

Now let me turn the call back over to Dave for some comments on our outlook for 2010.

Dave Berges

Thanks, Wayne. Our current operating plan for commercial aerospace assumes no recovery in the business of regional jet submarkets. For large aircrafts we assume that beyond the previously announced Boeing white body rate reduction there will be no other changes to aircraft build rates through 2011. Boeings Co. yesterday seem to support this assumption; Airbus is yet to give the 2011 guidance. But we are hopeful that the whole rates, and if so, we should see some sales recovery from the inventory de-stocking correction of 2009 once we clear the impact of the 777 rate reduction which we’ve already seen.

We do expect new program progress to provide a steadily increasing contribution to sales throughout the year and beyond. In space and defense, we expect an end to our sales for the F22 Program in 2010, but not the C17. Strong growth in rotorcraft programs are expected to offset the F22 demise after a number of quarters. And while we maybe down slightly for the year, we could be showing positive year-over-year comps by the end of the year.

Industrial sales are the most difficult to forecast. After a strong start for wind in 2009, our run rate dropped noticeably midway through the second quarter. With the apparent drop in the announced backlogs and factory schedules of our key win customers we anticipate a significant inventory correction in the near-term. While we are still optimistic about the long-term global growth of wind energy, until we begin to see a significant resurgence of orders for our wind turbine customers, we remain cautious for the full year industrial prospects in 2010, particularly in the first half. So for the total company with these assumptions, we would expect flat to slightly declining revenue on a constant currency basis for the full year, with the first quarter being the weakest, particularly when compared to 2009 strong first quarter.

From a performance standpoint, we attacked operational cost by aggressively reducing the number of days worked in the third and fourth quarter, and plan to do more as required in the coming quarters. While this approach doesn’t fully align our cost for sales, particularly in Europe, it does improve our cash flows and allows us to retain critical skills and capabilities we need for the longer term.

Beyond work schedules we have reduced global headcount by more than 15% since December of 2008, and we have reduced our cash to fixed cost basis at the plants by almost 10%. We do still believe in the future of composites, we hit the low, so we're using the time to improve our operational yields. We’ve made good strides in our drive to improve capital efficiency, which will allow us to reduce the CapEx rate of growth as new aircraft enter production.

2009 saw first flights of a number of new composite rich aircraft like the Gulfstream 650, the new Apache and a long last, the A400M and the 787. Our growth is inevitable. Thanks to the hard work for the Hexcel team in 2009 we’ll now be able to support it from a lower cost base and with less capital.

Now I'd be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question will come from Howard Rubel with Jefferies & Co.

Howard Rubel - Jefferies & Company

Good afternoon, David.

Dave Berges

Hi, how are you?

Howard Rubel - Jefferies & Company

Fine. Can you talk for a moment about some of the opportunities for incremental penetration, there is always airplanes, you talk about it all the time Dave about incremental improvements to the airplane that require more composite penetration. As you look at your R&D work, how much of its going towards that at the moment?

Dave Berges

Let’s say our R&D has a lot of qualification work that’s in it. A lot of basic research is in it, but we are always trying to work on the next generation of materials. I would say that a lot more that is working in next generation materials because that mold by a number of our customers seems to get broken. In that past it was -- they want to use what they used in the past that is the composite. So the baseline is sort of always the prior material or prior technology. It was that way to lead them [ph] finally moving to composites.

But in the last year or two, a number of our big customers have recognized that the potential for composites are well beyond what we have done in the past. And while they are more comfortable with the prior materials, they see the benefits of future materials. So there is a lot of work going on at many of our customers are trying to invent the next generation composite.

Howard Rubel – Jefferies & Company

And then one on operating leverage and gross margins, I mean, you've really lots of different businesses, you are not just one and lots of different plants and you are not just one. What percentage of your business units are operating at what you'd say are acceptable, gross margins and what percentage are below that, and my guess is one of the areas that's below is industrial?

Dave Berges

Well, I would say that if you exclude the new plants that don’t have that sort of critical mass volume that we anticipate for the future, none of the plants or operations or product lines are unacceptable from a margin perspective. We always like them to be higher. I think generally they are all appropriate to the capital requirements, that is industrial is lower but doesn’t require the capital. Fiber is higher, but it requires lot of capital. So, I think they are reasonably balanced and reasonably proportional. I would like the whole portfolio, now we don’t want to get it where it is in closing plants and exiting businesses, but we are pretty balanced now.

Howard Rubel – Jefferies & Company

Okay. Thanks, gentleman.

Dave Berges

Sure.

Operator

Our next question will come from John McNulty with Credit Suisse.

John McNulty – Credit Suisse

Yes, good afternoon. Just a couple of quick questions, with regard to the wind power business, would it being as soft as it is, first, can you discuss what you can do in terms of the cost structure that you have that business if you can wind it down, and how much we might expect to wind down over, say the next couple of quarters? And then as a follow-up, we have heard a lot about stimulus packages and focus on alternative energy and things like that and we have got, we have even seen a lot of awards handed out, when do you expect to see the demand pull actually? What are you thinking in terms of demand pull for wind power and when we might actually start to see a pick back up again?

Dave Berges

Well, John, as for a wind costs, we are looking at it but we're probably mostly focused on taking timeout because we don’t believe it’s going away or going to stay down for long. Obviously, with new players in Colorado and China, we spend quite a bit of energy starting those up working on qualifications and training people, so not too keen on doing anything radical there.

In Europe, we have to take another look at it what is the growth rate going to be in Europe, especially if our customers start to make turbine blades in China and the US, and there is not backfill so we'll have to take a look at that. Short-term though, if it's an inventory correction we want to do it by taking days out. It's pretty difficult to get paid days out, particularly in Europe, which is where most of our work is. So, we are a little concerned about who we'll handle inventory correction and when. We did just go through it with aerospace last year, so I think we'll get through.

As for stimuli, China clearly is very aggressive about their stimulus plans, they are little herky-jerky on whether they use local providers or European providers. So it's not clear what that picture will look like for our customers. The US does seem to be getting some traction but as you might have seen the reports for shares won last year are as expected, heavily dominated by General Electric who purchased their blades and don’t use Prepreg technologies at this stage. I think (inaudible) combined were in that 15% share range last year.

So we need Prepreg customers to win in the US. It does seem like we are starting to see some traction in US. And Europe still seems pretty slow. There have been simple words announced recently. That’s still maintaining, last I saw that they expect this year to be flat compared to last year which is better than what we are seeing of course. But I would say it's going to be yearend [ph] loaded as it is typically if there is a recovery.

John McNulty – Credit Suisse

Okay, great. Then just one question on the margins, you definitely saw some decent traction and improvement from 3Q to 4Q with a little bit of sales recovery, but also a lot of work on the cost side. How should we think about the margins in 2010? And you are guiding to a slightly softer revenues, can you have the margins up from the first quarter level, should they be kind of flattish, should they be down, like how should we think about that for the full year 2010?

Dave Berges

Well, you saw in the release that we've got a big depreciation and interest for that matter but fixed depreciation step up. We have to pay the fiber for the CapEx start that we ramped up year and a half ago. So, not lot we can do about the depreciation.

Otherwise though, I hope we demonstrated that we really put a serious focus on what we call cash fixed cost run-rate. So, I noted Obama last night talking about freezing discretionary spending that being 12% of the entire budget. Well, give me a break. Discretionary spending there is none and any of the rest of that 80% to 90% of the budget is discretionary spending everywhere and if you define this discretionary we’ll argue that it's not. So we don’t go there, we just say your cash fixed cost run-rate needs to get better, and unless we work on. So we came pretty close for the full year of variablizing this terrible downturn and I don’t see that relentless drive slowing.

Materials are to go automatically with sales. A direction in the US are pretty easy track with sales, directs in Europe are a more difficult. Overheads is the hard part, and of course, there is discretionary. So, maybe, we would try to move away from EBITDA once we lowered our leverage and to keep people focused on the cost of the capital spending. But EBITDA margin, we actually improved a little bit in 2009. 2008 was down a little bit to start of all the new plants but we gained ground on it in 2009. So, there might be a better proxy of a way to look at what we try to do all the time. So, recovering depreciation would be a pretty long time, but I'd really hope that if sales decline at all we can hold the EBITDA margins, and if sales go up we get some good leverage on it.

John McNulty – Credit Suisse

Okay, great. Thanks very much.

Dave Berges

Yes.

Operator

And our next question will come from Steve Levenson with Stifel Nicolaus.

Steve Levenson – Stifel Nicolaus

Good afternoon, everybody.

Dave Berges

Hi, Steve.

Steve Levenson – Stifel Nicolaus

Do you want to take a shot at what you think you can do for free cash flow in 2010? And do you expect net debt to go lower?

Dave Berges

Yes and yes. I would like you to give us credit for the $74 million free cash flow for 2009 and then put in a box and forget it. We do hope to have a good cash flow this year, but if sales are flat for the year it will be the bathtub that we talked about before that as we are going to have probably a down first half where we could maybe get some more working capital gains. And but then if we do start ramping up a little bit towards the end year as I hope, working capital at the year end point might be a little bit tougher. So, I don’t think we are going to get quite the benefit we got from working capital. I do think we still have opportunities in inventory. We always have cash outflow in the first quarter for a variety of reasons that are seasonal. But I would hope that we can – with the reduction of CapEx, and some further gains in working capital that we can have a decent year in cash sort of midway between zero when where we were last year if sales averaged what we outlined here.

Steve Levenson – Stifel Nicolaus

That’s good, that’s nice stuff really. You were mentioning before about replacing prior materials with new materials, and I just want to get clear on it, do you mean replacement aluminum with composite or do you mean maybe replacement somebody else’s composite?

Dave Berges

I'm sorry, I didn’t mean replacing, if I said that, I mean, the next airplane, the next wind turbine, the next generation fighter instead of using the existing composite material system that they are comfortable with from the prior airplane. They are now more aggressively pursuing advances. This is really a brand new industry compared to metals, and we have not yet begun to fight. So the customers seem to be comfortable with the idea of composites and recognize it, they can do more and instead of automatically assuming that they mark the same old material they used in the last airplane. They are more interested in seeing how far we can push it.

Steve Levenson – Stifel Nicolaus

Are you referring indirectly to Boeing 787 side of body situation?

Dave Berges

Now that’s a – the existing aircraft rarely would have a – aircraft that are as far along in development of the 787 rarely have – pardon me?

Steve Levenson – Stifel Nicolaus

I just mean your experience with the material and the problem they have?

Dave Berges

No, no, that’s just a design issue. I think, I don’t really know. I guess it would be the -- the honest answer. But if there is an excessive load in an area of an aircraft, it doesn’t matter what the material is made off. It’s designed to handle a certain amount of load. I am not talking about the performance of any existing materials. I think all aircrafts are safe. I think all composite materials are good including our competitors. I am just talking about the next generation. Well, for instance we've got what we thought it was the next generation material that we put on the A380 and we wanted that to be standard for the next 20 years. I don’t think its standard at all. I think we’re able to go beyond that now and I think the next aircraft we’ll be able to convince people that we can do better.

Steve Levenson – Stifel Nicolaus

Great. In terms of wind just United Technologies investment in Clipper Windpower [ph] potentially help you as, if I am correct you are doing business (inaudible) already.

Dave Berges

Yeah, well we've that’s all crossed our [ph] mind but it comes down to what the blade designs are and if the blade design, if we’re able to get there. Their R&D labs interested in doing something more with blade designs to make them lighter or more precise or more efficient and we certainly hope we can move in to some of our materials. But I wouldn’t call that near term opportunity.

Steve Levenson – Stifel Nicolaus

Okay. On A320 when they originally thought they were going up in the monthly gold rate? Is there Hexcel material or parts sitting there that are going to result in a drag this year or those being worked off?

Dave Berges

Well we had a pretty serious inventory correction in aerospace. As you know all through the air it was particularly pronounced a robust. I don’t fully understand the whole supply chain of flow when we have a new aircraft or when we have a reduction in build rates, but I speculate that the correction that we saw in Airbus which was pretty dramatic last year compared to what we should have been selling that it was a result of that line rate change. I am hopeful that we are through most of it. As I say, we did have slight sequential improvement the fourth quarter versus third quarter, so I am hoping we are past that inventory correction.

Steve Levenson – Stifel Nicolaus

Okay, thanks. Last question for Wayne, could you remind us please, I think you used to tell us what the revenue change would be in the quarter if there is a change in the exchange?

Wayne Pensky

So, Steve, well actually we disclosed in terms of operating income impact. So, for 2010 a 5% movement in exchange rate is about a $1.25 million impact on the operating income for the year, okay.

Steve Levenson – Stifel Nicolaus

Got it. Thank you.

Operator

Our next question will come from Mike Sison with KeyBanc.

Mike Sison – KeyBanc

Hey, guys. Good afternoon.

Dave Berges

Hi.

Mike Sison – KeyBanc

Could you give us feel on the regional jet business, sort of what the future is there, just your business has been chopping half to some degree, is there a secular -- an interesting secular trend there where they want to use more composites? And what do you think is going to happen to get this market back on track for you?

Dave Berges

Well, it’s regional end business jets.

Mike Sison – KeyBanc

Got it.

Dave Berges

Regionals, I think, have been painful for everyone. There is a bit of a secular penetration story in regional jets, but it's not anywhere as near as dramatic as the big aircraft. The C series from Bombardier is going to be pretty composite intensive so that’s sort of the first salvo. Embraer 190 is pretty composite intensive. The bill rate counts are particularly down in the smaller RJs, which don’t have much in the way of composites. I think in the regional jet business, it will continue to be slow because a lot of the driver for that full business segment was two tier wages for US legacy airlines.

On the other hand, some people like Republic are rightsizing by getting rid of small planes and upscaling to bigger planes, that would be positive. Aircraft emission standards worldwide are generally going to give us good long-term prospects. I'm sure Embraer is going to keep an on the C series and consider how they are going to reply to that.

So I think regional jets will be okay for a while but I don’t really look for that to give us a big lift. Business jets I noticed the departures are finally starting to move up again, that people are starting to fly again. So maybe that will come back soon but I'm not sure we’re through with inventory correction. There are a lot of players in that market. Some of them are pretty composite intensive, Gulfstream in particular is of interest, I think, they’re maybe the biggest on a dollar standpoint in the business jet world, and they did just launch both the 250 and the 650. They seem to be doing a little better than the others. It's got a horizontal stabilizer on the 650 that’s composite, but there is much smaller aircraft, much more accounts and much slower recovery in my mind.

Mike Sison – KeyBanc

Okay. Then for 2010 in commercial aerospace of the segment, it sounds like regional business jets basically flattish, right, from the fourth quarter level than-- you should have a better comp because there is an inventory de-stocking in 2010 versus '09 assuming the build rates that Boeing airbus has shared. So, I mean, shouldn’t the commercial aerospace segment be up in terms of sales?

Dave Berges

I think it could be. I think we said flat to up, if we didn’t somebody changed it. The business in regional jet I do think will be flat. We do have another quarter to go. So the first quarter last year they were still flying like crazy shockingly. And so we used to tell you that other commercial was 28% of our commercial air sales. In the second through fourth quarter they were down 40%. So if you just do the math on first quarter of last year and you say it's 28% of those sales were business jet and they are down 40 that $17 million first quarter hit. So we’ve got to fill that hole for the full year.

We do have a little bit of down from the 777. It's a good program for us and its down, two aircraft per year starting in this summer, it's per month sorry. So we’re starting to see that now. Otherwise though as we told you last year we thought that inventory correction was for bigger appliances overly impacting us to the tune of about 10% for steady state [ph]. So that should give us a (inaudible). So if you just look at the big airplanes, they are about 43% of our total sales and I do think Boeing and Airbus total sales will go up every quarter this year partly because of the inventory correction being done. And partly because of the new aircraft sales coming on the stream just offsetting the 777 parts. So it could easily be up this year.

Mike Sison – KeyBanc

Okay. The last question, and. I know it's a little bit longer term, but when you think about 2011, 2012, what do you think needs to happen to get top line growth in total, sort of, in the right direction to serve back on a growth path?

Dave Berges

I think if wind is just an aberration and a short-term correction, which I think it is, our definition of short term is the only question. We will get growing again in wind and that will carry industrial. Again, we at five years at 30% maybe won't be 30%, I mean CAGR, 30% CAGR, but you know that pulls the industrial pretty easily. I really do think that helicopters and Joint Strike Fighter and (inaudible) new aircrafts are going to carry space and defense back to their historical 7% to 10% without much difficulty. I think the big airplanes are going to start growing again if we don’t go down in line rates as some of you still forecast. I think the new aircraft will start to get us good growth. So, I expect that we will start growing again, second after this year and into next year.

Mike Sison – KeyBanc

Great. Thank you.

Dave Berges

Yes.

Operator

We will move on to Nigel Coe with Deutsche Bank.

Nigel Coe – Deutsche Bank

Thanks. Good afternoon, guys.

Dave Berges

Hi, Nigel.

Nigel Coe – Deutsche Bank

Most of my questions have been answered, but just, you have given some good color on 2010 subject to slight [ph] down sales, but have you seen say flat sales? Can you just give us some perspective on the kind of margin system of that and things about mix and perhaps showing FX into that equation as well. And then, normally we see stronger first half margins in a normal year, but 2010 won't be a normal year, so if you could maybe talk about that as well, Dave.

Dave Berges

I think the simple answer, not knowing what's going to happen to FX and Wayne’s got quite a bit of hedging. I think simple answer is, I don’t expect to see big swings in variable margins, in gross margin at all. I mean it will bounce around, so I mean year-over-year comps will be tough because remember the first quarter in 2009 we had some real good tailwinds. We had I think 13% operating income, as I recall, we had oil down at $30, we had favorable exchange rates, a great product mix and good volume.

So, except for the first quarter of last year, I think the second, third and fourth quarter sort of shows that we managed pretty well through the swings of mix and the volume. If you were just to normalize and say the whole year is going to be flat, I'd say everything else would be flat as well. It will more likely step up as the (inaudible) steps up. I do expect we’ll get good volume leverage. You see that in the Engineered Products group, in the fourth quarter our composite materials were down 20% and our engineered products were up 20%.

We had a fairly boring look in fourth quarter but underneath the cover that was pretty volatile. We got great leverage in engineering products. And if we could get growth going I think we'll get leverage, so I think we'll have a tough start in the first quarter because of the comps, a little bit difficult in the second quarter as unless Wayne starts kicking in. And then I hope for a pretty good second half and end up with a fairly average looking year with EBITDA percentages in the same neighborhood as what they were this year.

Nigel Coe – Deutsche Bank

So flat volume, flat sales, flat margins looks like to me.

Dave Berges

Yes.

Wayne Pensky

(inaudible).

Dave Berges

Right on in average and I remind you of the depreciation step up or not.

Nigel Coe – Deutsche Bank

Right, right.

Wayne Pensky

But I suppose I can cover that depreciation…

Nigel Coe – Deutsche Bank

EBITDA margins steady static.

Wayne Pensky

Correct.

Nigel Coe – Deutsche Bank

All right. And then just couple of clearance [ph] about, I think, Wayne, interest expense picking up next year, we had upside down. Could you may be talk about that being how much of that is sort of cash interest and how much is may be non-cash?

Wayne Pensky

Nigel, most of the increase in the interest expenses are actually I’ll call it non-cash, I like the better word, but we have capitalized interest expense on carbon fiber capacity in the past and we’re going to put in to place in April a pretty big trench of the capacity, and we will stop that and that’s will cause the interest expense to go up.

Nigel Coe – Deutsche Bank

And that’s the bulk of the $6 million.

Wayne Pensky

Correct.

Nigel Coe – Deutsche Bank

And then on the D&A, you said it's going to pick up may be $8 million next year, but does that continue in 2011, ’12 though?

Wayne Pensky

Yeah, it's long longer than that.

Nigel Coe – Deutsche Bank

I suppose [ph] actually. Okay, guys, thanks a lot.

Wayne Pensky

It actually is a little more than that because that -- putting the precursor capability online in April that Wayne is talking about, that’s effecting interest it is also when the depreciation is going to take the step.

Nigel Coe – Deutsche Bank

Hopefully that’s the stage the revenues look to about [ph].

Wayne Pensky

I am sorry, say it again Nigel.

Nigel Coe – Deutsche Bank

Well, probably in 2012 you probably have the rise in revenues --.

Wayne Pensky

Yeah, right.

Nigel Coe – Deutsche Bank

Thanks.

Wayne Pensky

Operator?

Operator

And our next question will come from Al Kaschalk with Wedbush Securities.

Al Kaschalk - Wedbush Securities

Hello guys.

Wayne Pensky

Hi Al.

Al Kaschalk - Wedbush Securities

Just taking the step further on the margin question. I guess that implies of margin EBITDA is flat but EPS is down is that fair?

Wayne Pensky

I am going to let you do a little work on that -- give me interest and I will give you average [ph].

Al Kaschalk - Wedbush Securities

Got it. Talk about what you meant Dave by -- not to be a cynical question but you said signs of lives [ph] in commercial aerospace, does that mean the part about the orders and deliveries sort of matching or the de-stocking completed. I hear your comment about relatively flat topline, but maybe if you could just add a little more color on, what you meant by that?

Dave Berges

Well, the sequential growth at both Boeing and Airbus is encouraging. The 787 flight was a good thing and while we aren’t exactly sure how that’s going to affect our sales, we are seeing a pickup in 787 material sales. Actually, every one of those new programs had a sequential increase in material sales. So the new programs beleaguered as they are, are starting to contribute the fact that we have had sequential growth at both Boeing and Airbus on the legacy programs suggest to me that the inventory correction is over, and we are getting back in line with what are the current run rates. So, I am not ringing the bell here, I am just saying that I think the worse is in the rear view mirror with respect to large commercial aircraft, which is 43% of our sales.

Al Kaschalk – Wedbush Securities

All right. So, I won't put words in your mouth, but my view on that is, is it sounds like you are starting to see some positive product contribution in sales on these new airframes and that should continue to ramp, albeit modestly throughout fiscal 10 -- would say would be different in your view maybe even a quarter ago?

Dave Berges

Right. Well, I might have anticipated that was going to happen, but now we are starting to see it happen so.

Al Kaschalk – Wedbush Securities

Yes, right.

Dave Berges

So, we said in my notes in the release that we said it's over 15% of a commercial aerospace sales now, we’ve never said that before, and I expect it will stay there, and that it be an increasing percentage from now on.

Al Kaschalk – Wedbush Securities

And then finally, could you talk about the CapEx program and related spend in 2010. I know you quantified sub 75 million but where is the dollars going in 2010 and the timeframe? I just heard earlier about capacity being put in place in April 2010 but what does it depend on?

Wayne Pensky

Well, the biggest bulk of our CapEx in recent years has gone to expanding carbon fiber capacity.

Al Kaschalk – Wedbush Securities

Right.

Wayne Pensky

Which we needed to do for USEC, which we needed to do for our military programs, which we will need to do for the A350, so we started adding capacity. The most recent big announcement of capacity which was 2007, we were going along at a pretty frantic pace in 2008 trying to bring it on line, we were actually trying to accelerate it. And then in 2009, we realized with the USEC delay or drop as well as the full market drop that we didn’t need it as desperately as we had thought.

So we slowed down the precursor line and we stopped work on the fiber lines. The cursor line and the fiber line still was the bulk of what we spent in 2009. We’ll still be the big part of what we will spend in 2010, so the precursor line that we slowed we are going to commission in the April, May timeframe, at which point we'll have to start the deprecation and well stop the interest. So we slowly roll them but we do want to get that precursor lying up and running because we do expect to start seeing the demand for precursor and pressure on our capacity next year there so. Our depreciation rate is $45 million or $46 million that’s still a good proxy for what the steady state CapEx requirements would be to 98 or whatever we did last year and the 75 or so this year it's still about carbon fiber capacity.

Al Kaschalk – Wedbush Securities

Okay, thank you. That’s all I have.

Wayne Pensky

Okay.

Operator

Next we’ll hear from Lucy Guo [ph] with Macquarie Research.

Lucy Guo – Macquarie Research

Hi this is Lucy calling in for Rob Stallard.

Wayne Pensky

Hi.

Lucy Guo – Macquarie Research

Hi. So, just two questions on the expense, how much more run-rate do you see in the strength of the rotorcraft sales that you are sighting will offset the up 22, what’s wrong?

Wayne Pensky

I don’t know. I would say that the demand at the end market level is still pretty strong from what I read with Afghanistan requiring even more assets than have been deployed. I have heard that the V22 which is important program for us is now in Afghanistan performing well. I have even heard talk that the air force is now interested in it. So that’s all good news. Beyond that even if things were flat there are a number of programs were there are new helicopter blade programs, were there redeveloping a new blade for existing airplane. So for instance the Blackhawk helicopter which is a very big helicopter in around the world I think 2500 of net been deployed. There is an upgrade that’s been develop that has a wide core composite blade and with the new engine it can provide an extra 500 pounds of lift. We’ve got a very good business in helicopter blade assistance, materials, sub assemblies, even some finished assemblies in our engineered products business. So, you see that engineered products group was actually up in 2009. Part of that is because they have a heavy Boeing element and the strike helped them, but another big part of it was a increased penetration in new composite blades for helicopters.

Lucy Guo – Macquarie Research

Okay. Great. And then just a follow-up on our conservation with Nigel, regarding margins in 2010, if I heard you correctly you said if revenues were flat, margins can be kept flat as well? And since you are getting more high representatives of commercial aerospace revenues from new programs, does that mean that margins on new programs are similar to those on legacy programs?

Dave Berges

We don’t have -- we don’t really have any products where we are unhappy with the margins, nowhere the margins are so lucrative we are embarrassed to talk about them. They are really pretty well balanced.

Lucy Guo – Macquarie Research

Okay. It sounds good. Thank you.

Operator

And our final question today will come from Avinash Kant with DA Davidson & Company.

Avinash Kant – DA Davidson & Company

Good morning.

Dave Berges

Hi.

Avinash Kant – DA Davidson & Company

I have a few questions. First, even if I understood you right, did you say that CapEx requirement for calendar year, Payne is going to be roughly $75 million?

Wayne Pensky

Yes, we said that it will be 75 max. So it depends a little on how the year develops it.

Dave Berges

If things start to recover, we would probably use the full 75. If there were other delays on programs or any other negative news, it could be less than 75.

Avinash Kant – DA Davidson & Company

I see, but that remainder will be pushed into ‘11 thereby?

Dave Berges

Well, I don’t know about the reminder but we'll have a plan for 2011 based on what we see as the demand picture in the A350 program in 2011, which we'll talk about later in the year.

Avinash Kant – DA Davidson & Company

Because most of the CapEx in '011 will be related to the 350 program, a majority of that at least?

Dave Berges

It depends on a bunch of factors, we haven’t actually laid out our 2011 spending plan yet.

Avinash Kant – DA Davidson & Company

Right. And you have been talking about seasonal weakness in the March quarter. Now from the commentary it looks like though the one business that could be weak is the wind business, but other than that do you expect sequential decline in any other business or is just primarily due to the wind business?

Dave Berges

Sequentially, the other commercial aerospace sub-market maybe will be flat, maybe will be down so I don’t know if there is inventory correction going there. Space and defense probably would be flat because we're already were down in the fourth quarter. Wind almost certainly will be. I'd say yeah, you are right. I didn’t think about it.

Avinash Kant – DA Davidson & Company

Okay. And in terms of legal expenses you had a pretty significant one, is it going to go zero in the few quarters or still going to have some?

Wayne Pensky

I would love to see legal expenses go to zero but the legal department probably wouldn’t. That settlement that was referenced in there was a one-time settlement that closes what is listed in our Qs and Ks as a patent dispute with a company called Gurit. So if you look at our recent filings on that subject that’s what it's addressing and its complete, (inaudible) and finished.

Avinash Kant – DA Davidson & Company

Right. And you have no other legal issues going on right now.

Dave Berges

Right. We always list, somewhat legal, open issues there are in our accusing case. I’d suggest you read that.

Avinash Kant – DA Davidson & Company

Okay and I believe you did say the tax rate should be around 30%?

Dave Berges

Correct.

Avinash Kant – DA Davidson & Company

Tomorrow.

Dave Berges

Right.

Avinash Kant – DA Davidson & Company

Perfect. Thank you so much. Thanks David.

Dave Berges

Yeah, sure.

Operator

That does conclude the question and answer session as well as Hexcel Corporation’s fourth quarter 2009 earnings release. Thank you for your participation.

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