Hexcel's (HXL) CEO Nick Stanage on Q4 2015 Results - Earnings Call Transcript

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Hexcel Corporation (NYSE:HXL)

Q4 2015 Earnings Conference Call

January 22, 2016 10:00 ET

Executives

Michael Bacal - Investor Relations Manager

Wayne Pensky - Chief Financial Officer

Nick Stanage - Chairman, Chief Executive Officer and President

Analysts

Myles Walton - Deutsche Bank

Gautam Khanna - Cowen & Company

Mike Sison - KeyBanc

Howard Rubel - Jefferies

Noah Poponak - Goldman Sachs

David Strauss - UBS

Robert Spingarn - Credit Suisse

Ken Herbert - Canaccord

Chris Kapsch - BB&T Capital Markets

Steve Levenson - Stifel

Operator

Good day and welcome to the Hexcel Corporation Fourth Quarter and Full Year 2015 Earnings Call. Today’s conference is being recorded. Hosting today’s conference are Mr. Wayne Pensky, Chief Financial Officer and Mr. Nick Stanage, Chairman, Chief Executive Officer and President. At this time, I would like to turn the conference over to Mr. Pensky. Please go ahead, sir.

Wayne Pensky

Thank you. Good morning, everyone. Welcome to Hexcel Corporation’s fourth quarter and full year 2015 earnings conference call on January 22, 2016. 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 and last night’s press release.

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

With me today are Nick Stanage, our Chairman, CEO and President and Michael Bacal, our Investor Relations Manager. The purpose of this call is to review our fourth quarter and full year 2015 results detailed in our press release issued yesterday. We are also going to cover our 2016 guidance. Since this is the first time in a while that we are providing the New Year’s guidance as part of our fourth quarter earnings call, we have posted a brief presentation on our website covering the details of our guidance.

Now, let me turn the call over to Nick.

Nick Stanage

Thanks, Wayne. Good morning, everyone and thank you for joining us today. As you have seen in last night’s release, we delivered another strong quarter with sales of $465 million just above the fourth quarter of 2014 sales in constant currency. Our key growth programs remain on track and performed as expected. Our operations continue to perform well delivering fourth quarter operating income of $81 million, with operating income margin of 17.5%, up strongly from last year’s period. Our diluted EPS of $0.56 was almost 4% higher than the fourth quarter of 2014.

For the full year, Slide 2 summarizes the record results we delivered in 2015. Sales were up almost 4% in constant currency to $1.861 billion from last year. We again set new Hexcel records for operating income, operating income percentage, net income and earnings per share.

Now, let me provide more details on our markets. And as usual, I will discuss year-over-year comparisons in constant currency. As you are aware, there was a significant strengthening of the dollar against the euro and British pound throughout 2015 as compared to 2014. This influences our results and some of this impact is not intuitive, but the bottom line is that we root for a strong dollar as our sales translate lower, while our income increases and so our margin percentages improve.

Our sales this quarter were again led by a 7% increase in commercial aerospace revenues versus 2014 as Q4 sales totaled over $326 million. For the full year, aerospace sales are up 7.6%. Total revenue from new Airbus and Boeing programs, which include the 787, A350, A320neo and 737 MAX increased more than 40% in the quarter as compared to Q4 2014, primarily driven by the A350 and A320neo. Airbus and Boeing sales for legacy programs declined modestly in the quarter. For the full year, revenue from new programs at Airbus and Boeing increased about 40% over 2014 levels. Legacy sales decreased about 5% for the year primarily due to the previously announced reductions in certain wide-body programs. Sales to other commercial aerospace, which includes regional and business aircraft, were about 15% lower compared to last year’s quarter and just higher than the third quarter. For the full year, sales were about the same as 2014 which was in line with our 2015 guidance.

Space & Defense sales for the quarter were $83 million, down about 14% as compared to the record quarter of last year, but sequentially up 7.5% from our third quarter results. For the year, sales were down approximately 7%. Our top 10 programs, which account for about 55% of our Space & Defense sales, are slightly higher in aggregate for the quarter and full year than in the comparable 2014 periods. The reasons behind the 2015 decline in this market following the one of three buckets. The first was the decrease in sales associated with the C17 program, which ended in 2014. Second, commercial helicopters, which now comprise less than 10% of Space & Defense sales, were about 25% lower than sales in 2014. And third, when you look across the more than 100 other programs we are on around the world, we experienced somewhat lower sales compared to 2014 due to a variety of unrelated reasons such as the planned decline of the Eurofighter build rates, lumpiness from new helicopter programs such as the CH-53K and unanticipated softness in several mature rotorcraft programs.

In industrial markets, sales for the fourth quarter were $55 million, down about 8% year-over-year and flat for the full year as compared to 2014. Wind energy sales were about the same in Q4 as compared to 2014 and were stable for the full year as well, in line with our 2015 guidance. However, the rest of industrial was down more than 15% in the quarter driven by lower recreation and other industrial sales. For the year, the rest of industrial was down about 2% as automotive growth was offset by lower recreation sales.

Now, let me turn the call over to Wayne to discuss some of the year’s financial details and give you our 2016 guidance.

Wayne Pensky

Thanks Nick. For the full year, gross margin improved nicely to 28.6% from 27.4% in 2014. Of the 120 basis point improvement, 55 basis points were due to exchange rates, with majority of the increase due to our continuous improvement efforts and increasing penetration of our intermediate and high strength carbon fiber.

For the year, selling, general and administrative expense was about $156 million, up about 8% in constant currency from 2014 as we added infrastructure to support our continued growth, the step up, including implementing our new ERP and other systems. And for the full year 2015, IT expenses were nearly $10 million higher than the amount incurred in 2014. We are very pleased to report that we have now completed the installation of our new ERP system and we look forward to optimizing in 2016 to generate improved efficiencies while we continued to ramp up for our expected growth. Research and technology costs of $44 million for the year were essentially flat with 2014 spend in constant currency.

For the full year, operating income as a percent of sales was 17.8% as compared to 16.8% in 2014. Exchange rates contributed 90 basis points to the increase for the year. The fourth quarters of 2015 and 2014 both had a benefit from the extension in December of each year for the U.S. R&D tax credits. These benefits added about $0.01 to EPS for the fourth quarter in each year.

Our full year tax rate is 26.1% and as a reminder, included first quarter benefits of $11.6 million related to the release of reserves for uncertain tax positions. Excluding all discrete benefits, our 2015 effective tax rate would have been 30.9%, slightly higher than our initial 30.5% expectation for 2015. For the year, free cash flow was the use of $4 million compared to the generation of $58 million in 2014, primarily reflecting higher capital expenditures and working capital usage offset by higher earnings. Cash payments for capital expenditures were $305 million for 2015 as compared to $260 million in 2014. On an accrual basis, our capital expenditures were $280 million – excuse me that’s $289 million in 2015.

At this point, let’s turn to Slide 3 to review our capital deployment in 2015. We ended the year with our gross debt to last 12 months EBITDA leverage at 1.35 times. We have steadily increased our leverage in recent years as we will balance increasing our leverage ratio with our commitment to maintain our investment grade rating. During the fourth quarter, we repurchased $46 million of our shares under our authorized share repurchase program. We have $204 million remaining under this program. If you look over the past 3 years, we have invested nearly $1.2 billion on the growth of the business and return to shareholders $760 million of cash for CapEx, $396 million was for share buybacks and $38 million was for dividends, which we reinstated in 2015. Additionally, the Board of Directors yesterday declared a $0.10 quarterly dividend payable to shareholders of record as of February 5 with a payment date of February 12.

So now let’s turn to our 2016 guidance, which starts on Page 4 of the slide deck. The midpoint of our 2016 sales guidance is $2.02 billion or what’s more easily said as 20-20 [ph]. This represents about 8.5% growth over 2015 including 2 percentage points of the growth coming from our Formax acquisition. Our EPS in 2016 is expected to be $2.44 to $2.56. This is based on us holding share count flat at 96 million shares as we expect to at least buyback enough shares to offset dilution. We expect our accrual basis capital expenditures will be between $280 million and $320 million, with free cash flow expected to be between $20 million and $60 million.

You now turn to Slide 5 we will provide some more color on our core markets. We again expect strong growth from commercial aerospace markets with sales up 8% to 10%. As you might expect, the A350 should be a growth driver this year, along with growth from the A320 ramp up, NEO ramp up and the mid single-digit growth in the business from regional jet market. Coming off the challenging 2015, we are expecting Space & Defense to be stable across the board in 2016. And our top three programs will remain the Joint Strike Fighter, the A400M and V22. Thanks to the Formax acquisition, we expect industrial market to be up 10% to 15% in 2015. Wind energy remains a significant contributor in this market and we expect those sales to be stable. We also expect our automotive sales to continue to grow nicely, while the rest of the industrial submarkets are projected to perform at a steady-state level.

Turning to Slide 6 and our remaining financial guidance, we expect depreciation and amortization to step up $18 million in 2016 as part of our capital expenditure investments come online to support our growth. We also want to remind you that the first quarter will see as typical use of cash as working capital begin to the seasonal buildup in the first half of the year. Additionally, we expect operating margins in the first quarter to be lower than the remaining quarters in the year as a result of the timing when we record our incentive stock compensation expense and additional costs in the first quarter from the startup of several new manufacturing lines. For the full year, we expect R&T spending to increase 8% to 10% as we invest in future growth opportunities and productivity initiatives. This includes development trials in our carbon fiber lines for new innovations to meet aerospace OEM requests for the next-gen aircraft and engine materials. We also continue to focus on faster cure resin technology for aerospace and industrial applications to address ever increasing rate demands and new higher volume programs. All this is done as a reminder to further enhance what we believe is the world’s leading advanced composite portfolio.

2016, we expect our effective tax rate will be 30.5% for the full year. Also due to our higher levels of income and the 2016 payment of previously deferred amounts, we are expecting our cash taxes paid to increase this year $25 million to $30 million. Lastly as you are all aware, we were aided by strong dollar versus the euro and the British pound. This is because our commercial aerospace sales to Airbus are in dollars, but we have some labor overhead and material costs denominated in euros or pounds. To protect ourselves, we hedge our exposures of the operating income line. Presently, we are about 80% hedged on 2016’s operating income. We place these hedges on a 10-quarter rolling basis. So the hedge rate for 2016 is more favorable than what we have in place in 2015 and should provide a $6 million operating income benefit. Looking out to the rest of 2016, each additional 5% movement will have a $2 million operating income impact net of our hedges.

Now let me turn it over to Nick for some final thoughts before we take your questions.

Nick Stanage

Thanks Wayne. As you have heard, we are expecting another strong year in 2016 as we continue to benefit from the growth in new model production in our commercial aerospace market. We expect our key commercial aerospace drivers to continue growing and we are still targeting $3 billion in sales in 2020. We also expect to generate $4.50 in EPS in 2020 and continue to expect to generate free cash flows totaling $1 billion for the 5-year period from 2015 to 2019. Despite the recent stock market turmoil the last few weeks, when I take a step back and look at Hexcel and our markets, I remain very optimistic about our future and confident in our operational focus. 2016 should be another busy and exciting year for us. For examples, we have the ramp-up of the A350 and the new re-engined narrow bodies A320neo, the 737 MAX as our core growth drivers in aerospace remain on track and continue to grow.

We announced earlier this week a new engineered core facility in Morocco, which will better enable us to globally support our customers’ growing demand for products that Hexcel has developed a unique skill set to produce. We completed the 100% acquisition of Formax in early January and look forward to fully integrating their technology and capabilities into our business. Our construction of a new carbon fiber and pan line in France is now full throttle, on schedule and on budget. And we expect to make significant progress in 2016 so that we can start the qualification process next year.

Our efforts for differentiating our materials for the premium automotive market are also bearing fruit. We are very proud of a recent announcement that disclosed Hexcel materials are being used to reinforce the B-pillar of the new BMW 7 series. Utilizing our novel fast cure resin systems, we have also developed a fully automated production system to make the material assemblies. We continue to invest in technology and innovation to ensure that we are the leaders in expanding the use of composites in all of our core markets. Last but definitely not least, we have a continuous improvement mindset and culture where operational excellence is a foundation of everything we do. We continue to efficiently execute on our investment plans in order to position the company for the forecasted growth as we support our customers by investing in technology, capacity expansion, manufacturing innovations, systems and our people.

Operator, we would now be happy to take questions.

Question-And-Answer Session

Operator

Thank you. [Operator Instructions] We will take our first question from Myles Walton with Deutsche Bank.

Myles Walton

Thanks. Good morning guys.

Nick Stanage

Good morning.

Myles Walton

Curious if you can start with talking about the 350 and you are obviously feeding a lot of your supplier chain content material and I am curious what you are seeing in terms of the variability of inventories in your suppliers, obviously it’s something that you would be keeping pretty tight read on. And what are in terms of feedback loops are you getting from your suppliers relative to production rates over the next 12 months?

Nick Stanage

So Myles, we do have very good visibility into the A350 supply chain and we ship to 40-plus suppliers and suppliers to Airbus around the world. So as you could imagine, everybody is not at the exact same point in time. And everybody’s parts and components don’t necessarily get installed at the same point in time in Airbus’ production schedule. So there is variation. There are suppliers that are ahead of others and there are some suppliers that are probably behind somewhat. But overall, I would tell you, I continue to be very impressed with Airbus’ performance on the A350. I think they have taken a very conservative approach. I think we have seen the pull come through very consistently with respect to our deliveries as compared to what we see in the supply chain, what we see in the supply stream as well as what we see in the Airbus plant. So, they were supposedly at 5 per month at the end of the year given that we ship about 6 months in advance. We were there sometime midyear and we are in the process of ramping up to deliver 10 per month by 2018. So, we see very good alignment. I know I believe there has been 15 delivered to-date. And I am also confident that deliveries will start to catch up with the production rate, which is fairly typical in a new launch of this magnitude.

Myles Walton

Okay. And one quick one, Wayne, what is the cash basis for CapEx expected to be in ‘16?

Wayne Pensky

Myles, we – on the accrual side, the midpoint is $300 million. I don’t expect the cash basis to be terribly different from that number.

Myles Walton

Okay, thank you.

Operator

We will take our next question from Gautam Khanna with Cowen & Company.

Gautam Khanna

I was wondering if you could elaborate on your automotive comments, how big is that business today and when you look out to 2020, how big do you think it might be? And a follow-up.

Nick Stanage

Well, as you know, our industrial, total industrial is about 13% and slightly over half of that is wind. So, the automotive market is a very, very small base and we really – it’s early to get into program specifics, but it’s more than just the magnitude on the size of this. It’s how we differentiated, how we continue to develop snap cure, fast cure resin systems where it can provide a sustainable competitive advantage for our customers like BMW. So, I think over the course of the next several years, we are going to continue to see strong growth there. But you have to keep in mind it’s on a small base. I am also excited that the technology that we develop here and the production throughput required in industrial and automotive applications helps us look at aerospace differently and provide more competitive solutions there as well.

Gautam Khanna

Okay. And just maybe for Wayne, can you comment on what the incremental margin is implied ex-FX in ‘16?

Wayne Pensky

Yes, Gautam. If you – and I will pull out Formax because you are bringing in a whole company and you don’t get over that. We are not quite at 25%. We are close, but not quite there. We are working hard to get there though.

Gautam Khanna

Okay. And last question on the defense and space business, what have you been seeing? I know a number of smaller programs have been a source of negative variance last year. What have you seen in those programs? Are you starting to see any sort of normalcy return or what gives you conviction that it’s a stable outlook there?

Wayne Pensky

With respect to – I am not sure I followed the question totally, but just with respect to Space & Defense sales for next year, if you look at our top 10 programs, which served roughly 55% of the total, actually those all look pretty stable including the top three, which is the Joint Strike Fighter, the A400M and the V22, actually we do expect to see some growth in the Joint Strike Fighter. But even as you look across on helicopters in total and all that, they all look relatively stable. I mean, part of it is having a low base to compare to, but there is nothing that’s obvious. I mean, you will see the Eurofighter drop a little bit and a few others. But in general, we have other things to offset it.

Nick Stanage

And there tends to be lumpiness in some of the development programs like the CH-53K, which had big sales in ‘14, a little bit less, but it’s a great program going forward.

Gautam Khanna

Thanks a lot, guys.

Operator

Our next question will go to Mike Sison with KeyBanc.

Mike Sison

Hey, good morning guys. Nice end of the year. In terms of your outlook for ‘16 when you think about the new aircraft programs, revenue was up 40% in ‘15. Is that going to be up kind of in that range again in ‘16? And what would legacy be? Will legacy be down again in ‘16?

Wayne Pensky

Yes. So Mike, it’s sort of a little interesting transition, it depends on how you count the NEO, right? You are starting to move – if you move all the NEO into new programs, it’s going to look obviously fairly big. And you are going to probably see some of our growth rates. That also means the legacy is going to start dropping as a result of that. But if you put that one aside, you do see a small drop in legacy just from the full impact of the A330 dropping down to 6 a month. We have already seen the 747 drop a little bit and they announced yesterday dropping a little bit more. But other than that, that’s the only news there.

Mike Sison

Okay. And then one quick follow-up on the A350, when you think about your guidance for ‘16, I would assume that – it assumes that there is a step up in production in ‘17 versus ‘16 and then you would feel that sometime this summer. Is that right?

Nick Stanage

I don’t think of it as a step up per se, Mike. I think it’s going to be more a gradual rate increase between now and 2018 up to the 10. So, we see increased production in ‘16 and equally, we will see similar increases in ‘17.

Mike Sison

Okay, great. Thank you.

Nick Stanage

Thank you.

Operator

We will go next to Howard Rubel with Jefferies.

Howard Rubel

Thank you very much. A couple of things. You had started out last year with a working capital I will call it a hedge against missing deliveries. How are you doing in terms of matching that surplus inventory against demand? It looks like you have wound it down a little bit. Your safety stock looks a little bit lower. Can you explain why?

Nick Stanage

Well, for starters, I didn’t get your first part of the question, Howard, on missed deliveries, but I think…

Howard Rubel

No, no, no, it wasn’t on missed deliveries. It was – I am sorry to interrupt, but no, I think you had started last year or carried through last year significant safety stock to ensure that certain programs were on, so that your supported programs. And it looks as if you are reducing that safety stock a little bit. And can you elaborate on the why the change in – or what appears to be a change in – I mean, it maybe confidence, it maybe a whole host of reasons?

Nick Stanage

So, when you think safety stock – and thanks, Howard, I understand your question. When you think safety stock, our safety stock for the programs that are in the process of ramping up rapidly, i.e., the A350, NEO, LEAP engines, we have not taken that safety stock down and really do not plan to until we reach more of a steady state, because basically, we are not being sole source. We need to make sure we protect our customers. So, that hasn’t decreased. With respect to other safety stock that we put in place when we are implementing the IT systems throughout the course of last year and other productivity initiatives where we needed to build a little back, we did burn a large portion of that off in the fourth quarter with a decline of I think about $21 million, right, Wayne? So, it wasn’t the new program development safety stock that was affected.

Wayne Pensky

But just to be clear, the safety stock for new programs is at the level where we want and – so it’s not increasing anymore.

Howard Rubel

I understand – that’s – that’s – so right, so the working capital change for sales is going to be a lot more matched to a constant as opposed to an accelerating number?

Wayne Pensky

Yes, correct. I mean, our target is to hold inventories flat in 2016. It won’t be by quarter and it will probably have a buildup in the first half. But for the year, we should be flat. And then receivables for us generally just moves as sales as they are quite clean.

Howard Rubel

Again, thank you on that. Staying with capital for a moment, I mean, you are frustratingly difficult to provide an outlook with respect to CapEx. And sorry, Wayne and every time we turnaround, there is a new plant or something like that. I mean granted, $20 million is small. How – can you provide any more color? I mean, I know once you get to 10 a month, you will probably breathe easier until Mr. Leahy takes the 350 up to another higher number or something else happens. So, how – I mean, how do you – you talked about a big free cash flow number, it looks like it’s all going to be jammed into 2019?

Nick Stanage

Well we, again just – and I know you remember this Howard, but it doesn’t prevent you from asking. We basically said we are going to spend about $1.1 billion between 2015 and 2019 to get to our $3 billion of sales in 2020. And that would be heavily front end loaded. And front end by definition is ‘15, ‘16, ‘17. So your read is accurate that provided we do not get a program that drives significant demand, which would require more CapEx, which would be a success from my perspective. And I would be thrilled to tell you about that and I will be the first one to tell you, that’s when the real cash flow would start to flow.

Howard Rubel

So if there is a very large military aircraft program that shows up and history would say you have done a nice job of providing fiber for a particular military aircraft programs, we would think that that’s already incorporated into CapEx profile?

Wayne Pensky

I would be a little careful on that, because I don’t think between now and 2020, there is an expectation of a significant – I mean it’s obviously you chose the word military, military program that will drive significant CapEx.

Howard Rubel

And then that’s – thank you on that. And then the last on Formax, if I do the right math right, it was about $40 million kind of run rate. And if we do the add it’s about $40 million. How do you, Nick either incorporate that so that it becomes a $50 million or $100 million business and am I thinking that it was just generally flat and now that you own it, it will be a big difference?

Nick Stanage

Well, that’s certainly not our intent. And again, I will go back to the motivation that prompted us to buy Formax and that is it’s a technology play. They have unique reinforcement capability that enables us to develop and produce higher performing fabrics, non-cramp fabrics that can perform better, lightweight fabrics that can be used in different applications, so our intent is certainly to integrate them. We have a team in place and the integration is going very well. But the intent is to grow that business and to migrate Hexcel fibers into that business more than they are today.

Howard Rubel

But my point is that it’s that while you have owned it and you are probably got good familiarity with it, in the near-term there hasn’t been a lot of growth, when do we see a knee in the curve or when could we see a knee in the curve?

Wayne Pensky

So Howard if you think in from ‘14 to ‘15, yes they are correct, there is not a growth – lot of growth. Some of that – remember some of it’s just simply exchange rates. But today, their business is 100% industrial. It’s going to grow because we are going to grow both in aerospace applications and industrial. So that’s where you see the big driver.

Howard Rubel

Got it. Thank you very much for your help.

Nick Stanage

Thank you, Howard.

Operator

We will take our next question from Noah Poponak from Goldman Sachs.

Noah Poponak

Hi, good morning everyone. I wanted to follow-up on that cumulative 5-year free cash flow target line of discussion. In order – it looks like in order to get to $1.1 billion of cumulative free cash 2015 to 2019, given you did about $300 million last year, the midpoint of the range, $300 million this year, if I just stayed at $300 million in 2017, you would then need to drop to $100 million as a run rate after that, is that the rough order of magnitude of how big the drop-off is. And then if I grow your cash from ops in that period at a 15% CAGR, which is what your 2020 earnings guidance implies, with that free cash – I am sorry, with that CapEx number, you don’t quite get to $1 billion, it’s closer to $900 million and so is there a working capital or other tailwind beyond the earnings growth pace?

Wayne Pensky

It’s a long question Noah. So, with respect to CapEx, you are in the right ballpark. If you think of today, our maintenance CapEx is in the $50 million a year range. And you got out those last 2 years and there is not a whole lot spent on growth. $100 million still provides you some opportunity for maintenance and a little beyond that. So you are in the general right ballpark. With respect to $1 billion of free cash flow, there is nothing – hard to look at your math and figure out there are any differences, but there is nothing obvious. I mean we obviously tend to hold working capital as tightly as we can, but I doubt that probably is a big enough number to explain here entire math, so not quite sure.

Nick Stanage

The only thing I would add is as you think about earnings growth, remember that depreciation is skyrocketing, but more EBITDA there than you think.

Noah Poponak

That makes sense. Yes, that could probably explain almost of it actually. And then just one follow-up on the outlook for stable rotorcraft next year, can you maybe just provide a little more detail on that, I guess I would have expected that to be down again, given what we are seeing in the commercial world. And I – if I remember correctly in 2015, you didn’t quite start to feel the negative impact from that until the second half, so I would have thought first half would still have the tougher comps from that situation?

Wayne Pensky

I guess the only thing I would say to that is remember commercial – when you look at the helicopter business, it’s now down to about 10% commercial, 90% military and so the second half of commercial isn’t that much lower than the first half. They are just not big numbers anymore.

Nick Stanage

If it’s not at the bottom, even if it goes down a little bit, it’s going to have a minimal impact.

Noah Poponak

Got it, okay. Thank you.

Nick Stanage

Thanks.

Operator

We will go next to David Strauss with UBS.

David Strauss

Thanks. Good morning.

Nick Stanage

Good morning.

David Strauss

Your forecast for our business jet and regional jet I think up mid single-digits for ’16, can you talk about how you are getting there, given the pressure that seems to be out there on at least on large cabin business jet?

Nick Stanage

Well, it’s basically driven by Gulfstream G650 and Embraer. That’s making up the bulk of our increases next year. And then we have a lot of other puts and takes, but we still feel good about the mid single-digits.

David Strauss

What exposure do you have at Embraer specifically?

Nick Stanage

Generally, speaking around everything, but for Embraer actually the regional jets look pretty decent next year. It’s – just to put in perspective, 5% on commercial – other commercial now is in the $8 million range. We are not talking about a big number anymore.

David Strauss

And Wayne, on the sales number how much of a headwind is in that or the sales guide, how much of a headwind do you have in there for currency?

Wayne Pensky

So it’s a little tough to answer. So if you compare 2016 sales versus ‘15, it’s at a rate – when we gave guidance the rate is a little higher than what it is today. So it’s pretty comparable with 2015 actual rates. I hope that helps.

David Strauss

Okay, alright. So not much of a difference between...

Wayne Pensky

Not really. It’s not much of a difference, but it’s fundamentally similar to the 2015 number.

David Strauss

Alright. And then last one for me, maybe some updated thoughts on leverage, I think back at the Investor Day, you talked about levering up by about $850 million over the ‘15 to ‘19 forecast period, you did about roughly one-fifth of that last year, is it safe to assume that this year, we are looking kind of in that same $150 million, $175 million range in terms of levering up?

Wayne Pensky

So I would view it sort of it that’s two pieces. One, leverage it will go up just as our EBITDA grows and we just told that the same debt to EBITDA leverage that we will get some from that. But we will probably continue to steadily increase the leverage ratio we are after, but it will probably slow...

Nick Stanage

While balancing our investment grade rating.

Wayne Pensky

Right.

David Strauss

Okay. Thanks guys.

Wayne Pensky

I think we are still on track towards that number. Nothing has really changed.

David Strauss

Okay, thank you.

Operator

We will take our next question from Robert Spingarn with Credit Suisse.

Robert Spingarn

Good morning everyone. I wanted to ask maybe this is a little bit smaller, you mentioned the 747, of course you got announcement last night from Boeing. I think that’s a modest impact for you. What’s your content there, just to refresh, a $1 million or so?

Nick Stanage

So, our content is 1.5 million. So, the announcement yesterday could be a $6 million to $8 million impact in ‘16.

Robert Spingarn

Okay. And then on a program that I don’t know how big a participant you are. In 777, what’s your content there?

Nick Stanage

It’s about $1 million.

Robert Spingarn

So there, we could see a little bit more meaningful impact. It’s not huge still and they haven’t announced anything, but is there any kind of conservatism built in for the 777 potentially coming down in rate?

Nick Stanage

Well, in ‘16, we do not have any change in that rate, because it hasn’t been announced, so no indication as of yet. We will remain flexible. And if Boeing does take it down, we will certainly adjust quick.

Robert Spingarn

Okay. Do you have any kind of protocol or just hedging strategy against the OEM build rates that you can apply? Are you fully confident that they will achieve what they say they will achieve?

Nick Stanage

Well, I would answer that a couple of ways. So, for example, on new programs, new launches, we tend to be a little conservative and we have the capacity. But in our forecast, we would probably hedge a little down just knowing that delays happen and we take a more conservative approach. On stable mature programs where we have very good line of sight on what the OEs are building, we tend to look at the supply chains and see if we see any tightness or oversupply. And we have very good visibility there as well, so not a lot of hedging in the mature programs.

Robert Spingarn

And on the NEO, you said this earlier NEO is one of those funny ones where you can kind of classify it either way, but do you go with the former or the latter philosophy on that one?

Wayne Pensky

So, we have moved it for now. I mean, it isn’t new programs and that gets a little bit more confusing.

Robert Spingarn

So you are essentially aligning with the 60 per month as the long-term…

Wayne Pensky

Well, we are aligning to the 46 per month this year, correct.

Robert Spingarn

So right, but long term, you are going with what they are telling you?

Wayne Pensky

Right.

Robert Spingarn

Okay, okay. And then just quickly on defense, it sounds like F-35 and Eurofighter kind of offset and allow you to look for a stable defense line in ‘16. Are there any other programs we should be mindful of where there could either be upside or downside?

Nick Stanage

I guess I would point out the A400M. We always watch that. It has a little bit of growth given the economy and the environment, that’s on my radar. V-22 has held strong. So, we are looking for another good stable year this year as well. So, there is not – we are on so many programs, there is really not other program specifically that would drive a material change in our outlook.

Robert Spingarn

Okay. Okay, very helpful. Thank you.

Nick Stanage

You are welcome.

Operator

We will go now to Ken Herbert with Canaccord.

Ken Herbert

Hi, good morning.

Nick Stanage

Hey, Ken.

Ken Herbert

Wayne or Nick, which rate are you shipping at now on the 787 or how much of the step up from 10 to 12 do you see this year or how much have you seen perhaps in ‘15 just considering sort of timing and lead times on that?

Wayne Pensky

It’s pretty hard to answer that exactly for 2015. It’s probably – it’s probably – was probably 10 a month for the full year. I think we are...

Nick Stanage

Maybe slightly above that.

Wayne Pensky

Yes, but we didn’t see too much, but you will see it more towards this year that can step up to the 12, that is.

Ken Herbert

Okay. And I would imagine if you think about that step up as just sort of give or take 70 million, 75 million, do you see – how much of that would be captured in your guidance or sort of how do you expect to see that step up playing out from a timing standpoint?

Wayne Pensky

So, just to be clear, it’s – we are $1.5 million per ship set, so it’s $3 million a month.

Ken Herbert

Yes, okay.

Wayne Pensky

I don’t want to get into quarter-by-quarter guidance, but you will see it step up slowly throughout the year – I shouldn’t say slowly.

Nick Stanage

It’s going to be steady through the year.

Ken Herbert

Okay, okay. So just maybe you would – by the midpoint of the year, you would probably be at rate 12, I would guess?

Nick Stanage

Well, you would. Just based on what we have heard, that’s a reasonable guess.

Ken Herbert

Okay. And then just on the – part of obviously, the lower free cash flow in ‘15 relative to when you started out the year in the third quarter when you brought that guidance down, you obviously talked about the inventory and the safety stock that you have discussed. I think it’s the time you mentioned part of that as well was a little pull forward on some CapEx from an opportunistic standpoint. Is that something that you could see again in ‘16? And where might you – maybe can you just talk a little bit about the puts and takes there as you look at the CapEx this year or the opportunity to maybe take advantage of some opportunities to pull things forward and how that – where could you perhaps see those opportunities?

Nick Stanage

So, you can imagine, we have hundreds of CapEx projects going on around the world. And I am very proud of the job that the team is continuing to do with respect to managing those projects on track, on budget, achieving the stated throughput. We really basically – it’s pretty simple. We just aligned with our customer demand schedules. And as we increase productivity and have more capacity than what we may have had when we did our original CapEx planning, we may push things out. If a program looks like it, it may be a little more aggressive, we will pull them in. So, there is no plan to pull CapEx in unless there is a reason where a customer program and the demand requires it. So, we feel good about the $300 million midpoint for this year and I would expect this to be right around that number.

Ken Herbert

Okay, that’s great, Nick. And then just finally on Formax, I mean, it sounds like it’s a bit considering the incremental investment there, you are happy with that and the comments around the exposure and the potential growth outlook seem encouraging. Has that experience or has anything else changed maybe the thinking around potential acquisition opportunities or other inorganic investment opportunities for you? And is there anything else you can comment there in terms of what you might be seeing or looking at?

Nick Stanage

Well, we are looking at things very similar to Formax. That’s when you think about what interest us, it needs to be a technology play, a bolt-on, what’s going to enhance the position we already have, what’s going to enhance our financial performance versus where we are today. So, granted, Formax as an acquisition is not going to translate at the operating income leverage that we are going to strive for always. But down the road, it will and it will do more than that with the top line growth it will generate, so not a lot to add on other deals, but we are continuing to look.

Ken Herbert

Okay. Well, thank you very much. Great start to the year.

Nick Stanage

Thank you.

Operator

We will take our next question from Chris Kapsch with BB&T Capital Markets.

Chris Kapsch

Yes, good morning. So, obviously, there is a lot of consternation about the order backlog and the commercial aero cycle more generally. So, I just wanted to follow up on the line of questioning about your forecasts and as it ties to what you have described as good visibility into the supply chain and aligning your forecast with your customers’ demand schedules. Just want to understand if you could provide a little more color? The forecast and the guidance that you provide – are those based on publicly stated production build rates of your customers or are they specific orders to you? And then you kind of touched upon this, but to what extent do you discount or risk adjust those whether it’s the production rates or specific order forecast that they provide you?

Wayne Pensky

First, welcome back, Chris and I will start and then I will let Nick add if appropriate. With respect to when we are looking out to 2020, that’s based on basically publicly announced build rates or the build rates beyond that. If it’s not publicly announced, what our supplies – excuse me, what our customers have told us. With respect to 2016, it’s really more about discussions with our customers of what they actually expect to order. Now, we always check with the customers to make sure that’s in line with build rates to make sure everything makes sense in that, but that’s actually based on each customer by customer what they actually expect, which on an overall basis is in line with announced build rates, so not really a whole lot of difference there. That’s very easy on commercial aerospace when we get to Space & Defense and industrial, it gets a little bit more – there is lot more variability, obviously.

Chris Kapsch

I see, okay. And then a follow-up on this companywide ERP implementation obviously a big endeavor and I think you said you expect process optimization benefits in ‘16. Is there any way you could qualify or quantify what those anticipated benefits might be are those in the forecast? And also as you reap the benefits from a massive ERP implementation, is there opportunity for current capacity to debottleneck, so it could somehow free up free capacity defer CapEx that kind of thing?

Nick Stanage

So I will start here. First off, the ERP implementation, again I have to give my team kudos here for the fantastic job they have done, implementing every single site manufacturing and administrative without negatively impacting our customers. So as you know, we stepped up costs last year for two reasons. One for the ERP and we pulled in to make sure we could finish it by the end of the year. So the benefits do not come instantaneous. So we still have to spend this year in the IT arena, on ERP as well as multitude of other systems we have implemented. And over the course of the year, I would expect the productivity initiatives, the supply chain efficiencies to start being realized. But this is an ongoing capability. This really provides us the tool to take our systems and our processes to the next level, but it’s going to take time as well.

Chris Kapsch

Okay. Is greater capital efficiency one of the anticipated benefits over time and anyway to quantify that? Thanks.

Nick Stanage

So if you are talking about pure machine output, I would say that’s more limited. If you say supply chain, working capital efficiency, that’s where the big advantage will come, and really not a point where we want to give specifics on what our internal targets are for that.

Chris Kapsch

Fair enough. Thank you.

Operator

We will go next to Steve Levenson with Stifel.

Steve Levenson

Thanks. Good morning everybody.

Nick Stanage

Hi Steve.

Steve Levenson

Just on A320, are you including all the content there, including the engine rather than breaking out the engine and if it’s possible, could you tell us either the content or at least the percentage going to the engine as opposed to the airframe?

Nick Stanage

Well, while Wayne is getting through his notebook, I will tell you we are on track, Steve. When we give the numbers, for example legacy at 300,000 and a target to be at 450,000 on the NEO, I can tell you we are on track and doing very well there. We are not ready to declare the specific number. We want the program to stabilize a little bit, now that it’s just started being delivered as of this week. We haven’t in history provided the breakout. And I am waiting to see how Wayne is going to answer this.

Wayne Pensky

So Steve, when we talked about 300,000 to 450,000 for the A320neo, when you think about that most of that increase is in the engine themselves and I would say overall, I would sort of view it as a 60-40 split, meaning 40% towards the engines themselves. But that’s a rough number, but it’s in that range.

Steve Levenson

Okay, got it. Thanks. And to get to your 2020 goal, is there anything you have to win and if you win anything between, is it more likely to pay the dividend after 2020 as opposed to during the period you have mentioned in reaching your goals?

Nick Stanage

So since we talked about the 2020 vision, it’s hard to believe it’s been a year already. I feel very good about where we are. And to your point Steve, most programs that get awarded today, the revenue really is not going to start flowing until 2020 or later. So we have very good line of sight on the programs. There are certainly baskets out there and applications where we are working to maximize our content that are completely done. But based on our historical win rate, based on our opportunity portfolio, we feel really good about 2020.

Steve Levenson

Got it. Thanks. And last one, in terms of getting new launch qualified, is the amount of time it takes pretty much the same or you have been able to bring that down?

Wayne Pensky

I would say in certain cases, it's close to the same. We are making improvements. We are working with our customers and continue to drive certain areas down. But some of it is just brute force on running samples, making specimens and it is time-consuming.

Steve Levenson

Got it. Thanks very much.

Nick Stanage

Thanks Steve.

Operator

That concludes today’s question-and-answer session and brings to the end of our conference for today. Thank you for your participation.

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