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Hexcel Corporation (NYSE:HXL)

Q3 2012 Earnings Call

October 23, 2012 10:00 AM ET

Executives

Wayne Pensky – SVP and CFO

David Berges – Chairman and CEO

Nick Stanage – President and COO

Michael Bacal – Communications and IR Manager

Analysts

Amit Mehrotra – Deutsche Bank

Richard Safran – Buckingham

Howard Rubel – Jefferies

Steve Levenson – Stifel, Nicolaus

Abhi Rajendran – Credit Suisse

Michael Lew – Needham & Co

Ken Herbert – Imperial Capital

Peter Cozzone – KeyBanc Capital Markets

Kristine Liwag – Bank of America Merrill Lynch

Noah Poponak – Goldman Sachs

Avinash Kant – DA Davidson

Operator

Good day and welcome to the Hexcel Corporation Third Quarter Earnings Conference Call. Today’s conference is being recorded.

At this time I would like to turn the conference over to Mr. Wayne Pensky, Chief Financial Officer. Please go ahead, sir.

Wayne Pensky

Good morning, everyone. Welcome to Hexcel Corporation’s 2012 Third Quarter Earnings Conference Call on October 23, 2012.

Before beginning, let me cover the formalities. First, I want to remind everyone about the Safe Harbor provisions related to any forward-looking statements we may make during the course of this call. Certain statements contained in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments, and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the company’s SEC filings, including our 2011 10-K, our Third Quarter 10-Q, and last night’s press release.

Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be re-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; Nick Stanage, our President and COO, and Michael Bacal, our Communications and Investor Relations Manager. The purpose of the call is to review our 2012 third quarter results detailed in our press release issued yesterday. First, Dave will cover the markets, then I will cover some of the financial details, and Dave will return for some final comments.

David Berges

Thanks, Wayne. Good morning everyone. We had another very good quarter with sales of $392 million, 13% better than last year on a constant currency basis. And adjusting out one-time items from last year, diluted EPS of $0.39 for the quarter was a 15% increase over 2011. Thanks to good execution and conversion on incremental sales, our $60 million operating income was 23% over last year and resulted in a margin of 15.3% of sales, a 150 basis point improvement over last year.

Commercial aerospace sales of $234 million for the quarter were up over 13% in constant currency from last year’s third quarter with the growth coming primarily from large aircraft. Revenues for new programs again increased by more than 30% for the quarter versus the prior year and now account for more than 30% of our total commercial aerospace sales. Sales for legacy platforms at Airbus and Boeing were up 9% from the third quarter of 2011 and we believe are currently in line with build schedules. Sales to other commercial aerospace, which includes regional and business aircraft, were about the same as the third quarter of the prior year, but we’re down about 10% from the robust levels of the first half.

Space and defense revenues were about $91 million up over 14% on a constant currency basis versus the third quarter of last year. Growth in both civil and military rotorcraft continue to be the primary drivers, though we’re also beginning to see the impact of the new composite rich European A400M transport.

In Industrial markets sales for the third quarter were $67 million up about 11% year-over-year on a constant currency basis. Wind sales were up significantly over last year’s third quarter but were down sequentially, almost 20%, as we begin to see the impact of the U.S. slowdown. Sales from our U.S. wind prepreg facility were down both year-on-year and sequentially and now account for less than 30% of our global wind sales.

Let me return the call to Wayne for some additional comments on the financials.

Wayne Pensky

Thanks, Dave. Gross margin of $99 million for the quarter was 25.3% of sales as compared to 24.6% in the third quarter 2011, due to good leverage in the sales volume.

Our reported sales, general and administrative costs were only 1% above last year and just 3.5% over last year in constant currency. Our research and technology costs were up nearly 17% over last year in constant currency as third quarter spending levels were consistent with the first half of 2012 run rate. In total, SG&A and R&D combined grew less than our revenues and thus improved at 10% of sales versus 10.7% of sales for the third quarter of 2011.

Foreign exchange rates contributed about 30 basis points to the higher operating income percentage in the quarter as compared to last year. Our operating leverage continues to be strong and after adjusting for exchange rates we delivered 24% incremental operating income on the sales growth for the quarter and the year-to-date leverage is almost 26%. Our year-to-date effective tax rate is now 31.6%, down slightly from the first half rate of 31.8%. As a result our third quarter effective rate was 31.1%. As a reminder, 2011’s third quarter rate of 27.4% benefited from a release of $1 million of reserves for uncertain tax positions and a reduction of our estimated tax rate for 2011 to 31%.

Free cash flow for the first nine months of 2012 was a use of $58 million as compared to a source of $12 million in 2011. This reflects the higher capital spending for ongoing capacity increases partially offset by $49 million increase in adjusted EBITDA. Through the end of September we paid cash of $209 million for capital expenditures in 2012 as compared to about $100 million in 2011. Our year-to-date accrued capital expenditures were $175 million and we are now targeting accrued capital expenditures to be between $230 million and $250 million for this year, a modest reduction from our prior estimates of $250 million to $275 million. We expect we’ll use between $40 million and $60 million of cash for the full year.

Net debt at the end of the quarter was $253 million, which is a decrease of $14 million from our debt level at the end of June.

Now let me turn the call back to Dave for some closing remarks.

David Berges

Thanks, Wayne. As you’ve seen we’ve updated our full year 2012 guidance. We now expect sales to be in the range of $1.560 billion to $1.590 billion. This narrows the range from our previous guidance and falls in the upper quartile of our original 2012 guidance if you adjust for the $40 million impact of the currency translation in the year. But based on continued strong leverage on the growth we’re increasing the top-end of our adjusted EPS guidance from $1.55 up to $1.59. Regarding capital expenditures, as Wayne mentioned, we’ve lowered our forecast for this year and next to reflect recent yield and productivity improvements, reduced cycle time to replicate and qualify new lines, plus our latest demand model.

We’d be happy now to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) and we’ll take our first question from Amit Mehrotra with Deutsche Bank.

Amit Mehrotra – Deutsche Bank

The mix between the newer 55 meter blade and the older 44 meter blade in the business?

And can you just help us in how we should think about what the net impact of the lower volumes would be, but the higher incremental content on the larger blade?

David Berges

Amit, the first part of your question was cut off, could you repeat it please?

Amit Mehrotra – Deutsche Bank

Yeah, sure, can you just give us the mix in the wind business between the newer 55 meter blade and the older 44 meter blade in the business?

David Berges

I don’t know what the production mix will be. The orders – and the best is backlog, is best I can determine look to be about 25% or 30% of the backlog is the newer large turbine. And those blades take upwards of 50% more of our content, is best we can determine. So whatever decline there might be from production tax credit or other global pull back on deliveries from Vestas will be at least partially offset if not completely offset hopefully by the improved mix.

Amit Mehrotra – Deutsche Bank

Okay, that’s helpful. And just one question on the revised CapEx guidance. I mean does this imply the 2012 CapEx is the peak and we’re on a sliding slope starting next year or is the reduction more of a deferring and we’ll see CapEx creep back up when there’s more clarity on the – on some of the timelines in the new programs?

David Berges

Well we’re long term thinkers. I’m hopeful that we will see additional peaks in the next couple of decades. But I would say based on what we know right now this year would at least, on the interim, be a peak. As you know our biggest capital driver comes when our carbon fiber’s specified. So we work hard to keeping in sync with major drivers like the USEC Centrifuge project, the Joint Strike Fighter, A350 and jet engine programs. We can’t miss on the short side so we plan our balance sheet for the most aggressive scenario and scale back as we get new input.

So that’s really what the reflection is. But probably as, or more importantly, the vast majority of our major investments are on track to meet or beat our output per capital targets and thus we’ve been able to reduce contingencies on our spending plan. So our ongoing spend rate per dollar of sales is likely to be better than what we would have envisioned two years ago.

Amit Mehrotra – Deutsche Bank

Okay, just one last quick one may be for Wayne and then I’ll hop off, this, it’s on the Gurit infringement claim, when do you expect that to get resolved? What are some of the milestones we should watch out for? And should we expect any reserves there or are there already reserves in place? How should we think about that?

Wayne Pensky

Yeah we have not taken any charges against that as we don’t believe we have any liability. But it’s a litigation matter and who knows how long it will take, but we’ll keep everyone informed as it goes along.

Amit Mehrotra – Deutsche Bank

Okay. All right thanks a lot.

Operator

And we will take our next question from Richard Safran with Buckingham.

Richard Safran – Buckingham

Hi good morning.

David Berges

Hi Richard.

Richard Safran – Buckingham

Just had a quick question here on CapEx and free cash flow. You reduced CapEx $20 million to $25 million. Your free cash flow is now use 40% – 46% versus 50% – 57% like previously so that’s a $10 million to $15 million improvement. I just was wondering if you would discuss why the reduction of CapEx is not completely flowing down to free cash flow.

Wayne Pensky

Yeah Richard, I’d argue it was pretty close in general. We only dropped CapEx the $20 million to $25 million, includes working capital and everything else when you start looking at your total cash flow. So I hope it goes down a little bit further but right now three fourths of the year looking into it, we think we made the appropriate change.

Richard Safran – Buckingham

Okay – is this anything to do with like accrued versus cash or anything?

Wayne Pensky

By the time you get to the fourth quarter, the accrued and the cash are kind of in line. We probably confused a little bit of – most people earlier in the year. If you remember in the fourth quarter of 2011 we incurred a lot of CapEx commitments that we ultimately didn’t pay for until the first quarter and so the cash piece for the first quarter of 2012 was much higher than the accrued piece, but they’re now sort of generally in sync.

Richard Safran – Buckingham

Okay. Thank you very much.

Operator

And we will take our next question from Howard Rubel with Jefferies.

Howard Rubel – Jefferies

Thank you very much. Hey Wayne, I can’t understand how you could miss your FX number by 2%, I mean is really some I’m shocked by. But no in all seriousness very nice numbers. But a little bit of fourth quarter – when we look at the seasonality typically fourth is a little bit stronger than Q3, Q3 again very nice numbers. Is it FX that is impacting what you’re thinking about Q4, or is it some schedules, or can you elaborate a little bit on that?

Wayne Pensky

Well, I guess Howard, if you look at the midpoint of our guidance for the fourth quarter, or what’s implied I guess I should say, it is down a little bit from the third quarter. I’d say probably wind is the largest contributor to that. As I believe if you look at the aerospace markets, it’s probably pretty flat with the third quarter.

Howard Rubel – Jefferies

Okay, that makes sense. Are you yet getting anything more than sampling, Dave, on LEAP-X and on NEO?

David Berges

Well, it depends on the component. The LEAP-X engine has been in development for years actually and so the front fan blade, which is an infusion carbon fiber blade, has been in development for quite a number of years. So we’ve been shipping our intermediate modulus fiber for quite some time. There is a lot of development work going on, on containment rings and acoustical treatments and a number of other programs that I guess I would still call sampling phase as the designs are finalized.

Howard Rubel – Jefferies

Because I mean at some point you’ll have to think about adding that as one of the new programs that you address as opposed to the sort of four that you’re indicating now and I was just trying to get a sense of either volumes or timing?

David Berges

Well it’s good point. I actually haven’t looked at whether the volumes are enough on those two programs to start to include in new programs but we’ll take a look at that over the coming quarters.

Howard Rubel – Jefferies

And then the last question is SG&A seems to be well under control, is that again partially attributable just to FX or is there something else you’re doing? Because you did get some very nice operating leverage on – it wasn’t all – excuse me it wasn’t all cost of goods, it was also a very good control over SG&A. Because you would take that…

David Berges

Well I think control over SG&A is one of the hardest things to do in a corporation that’s growing as quickly as we are. I think we could probably do better, quite frankly. There was some FX help but there’s no dramatic change one way or the other in what we’re planning, we just try to do what we need to do to support the growth without getting carried away, and having it grow proportionally so that we can maintain our plus 20% incremental leverage.

Howard Rubel – Jefferies

Is the census up sequentially in year-over-year? Do you have those data points?

Howard Rubel – Jefferies

I’m sure it is year-over-year.

Wayne Pensky

Yeah it is – I’m sorry, Howard did you say people?

David Berges

Yeah.

Howard Rubel – Jefferies

Yes.

Wayne Pensky

Yeah we’re up roughly 400 or 500 people from last year.

Howard Rubel – Jefferies

Thank you very much. Thank you.

David Berges

Sure.

Operator

And we will take our next question from Steve Levenson with Stifel, Nicolaus.

Steve Levenson – Stifel, Nicolaus

Thanks, good morning everybody.

David Berges

Hi, Steve.

Steve Levenson – Stifel, Nicolaus

Could you talk a little bit about opportunities on some of the new engine designs that are coming, and in relation to that opportunities on a 777 revision that may have a composite wing? Do you think you have an opportunity to displace the incumbent or just an opportunity for some incremental growth?

David Berges

Well as I said on prior calls the incumbents are both another composite player and another aluminum manufacturer. So it’s a hill to climb for sure, but there’s no program that we don’t go after if it’s going to fly. So I am very certain, though, that our content on any new airplane will increase. My competitors could probably say the same things at least those in the composite world. I think our focus right now is, as you pointed out at the beginning: engines. It all starts with efficiencies that are gained with new engine technologies, whether it’s the single aisle or any change to existing aircraft. So we’re working with all of the engine manufacturers trying to maximize our participation and content and help them improve their acoustical signature and their structure and their weight.

Steve Levenson – Stifel, Nicolaus

Okay, thanks. And I understand that you recently expanded the plant in Parla, Spain. Can you talk about that a little bit? Is that actually in production now or is there a qualification process there too before you start delivering parts? And is that plant specifically for A350?

David Berges

Nick, you were at the grand opening, do you want to..?

Nick Stanage

Yeah, we had the grand opening a few weeks back and it is a prepreg plant that’s an expansion from our other prepreg within the area, primarily to focus on A350 but also other European customers as well. The line is in the process are being qualified now and then we’ll shortly convert into production.

Steve Levenson – Stifel, Nicolaus

Okay, and is that three months, six months?

Nick Stanage

We’re not assuring that...

Steve Levenson – Stifel, Nicolaus

Okay.

Nick Stanage

At this time.

Steve Levenson – Stifel, Nicolaus

Got it. Thank you very much.

Operator

And we will take our next question from John McNulty with Credit Suisse.

Abhi Rajendran – Credit Suisse

Hi, this is Abhi Rajendran calling in for John. Couple of quick questions. So on free cash flow, looking to 2013 with continued earnings growth and now the lower CapEx forecast, is it reasonable to assume that you should be free cash flow positive, and if so could you maybe touch on some of your key priorities for cash usage as you start generating cash in the next year and beyond?

David Berges

Well, we’re going to try to give guidance for the year after we finished our planning cycle. So about mid-December we’ll give you some color on that. But we certainly expect to be cash positive next year as we do for the second half of this year. We have got a pretty good track record going here of EBIT and EBITDA expansion, I think 10 quarters in a row. So we have a lot more to work with and with CapEx spending going down we certainly expect to deliver some cash next year. As for what we do with the surplus, we don’t consider ourselves in a surplus category yet until we’ve fully funded our organic growth. But beyond that all the obvious candidates will be considered.

Abhi Rajendran – Credit Suisse

Okay great. And then a quick question on space and defense, what sort of growth can we expect in this business looking to next year, given some of the moving parts in that market including rotorcraft, Joint Strike Fighter as well as some of the other platforms.

David Berges

Well again we haven’t given a detailed guidance for next year yet. We have said for some time now that we do think the secular penetration of composites in this market and the conversion of many rotorcraft to composites blades plus the emergence of the A400M will help offset any softness in older platforms. So we do expect to continue to be able to deliver single digit growth. The more this year looks like double digits the bigger hill we have to climb. But if you smooth it out over the next few years I think we can keep the average to be above neutral and in the single digits.

Abhi Rajendran – Credit Suisse

Okay great thanks very much.

Operator

And we will take our next question from Michael Lew with Needham & Co.

Michael Lew – Needham & Co

Thanks and good morning guys.

David Berges

Hi Michael.

Michael Lew – Needham & Co

Hi. With regard to the reduction in planned CapEx you’d highlighted a better productivity and more qualified capacity coming online. Could you provide a little more granularity as to where the gains were made? Was it in carbon fiber, fiberglass, resins honeycomb, or some of the areas?

David Berges

Well, every program that we approve has targets for what the cost is going to be, what the contingencies are and what the output per capital dollar will be I would say 90% of the projects that we’ve launched in the last two years have met or beat those targets. So as we rework our outlook, there are some of the worst case scenario contingencies that we’re able to take out of our outlook, so it’s just sort of a good performance by Nick and his team.

Michael Lew – Needham & Co

Okay and with regard to the wind energy business, I’m curious does your outlook also incorporate the big wind farm that was recently approved in Wyoming that could begin construction next year as your biggest customer? You know, that’s been named as a potential supplier? It’s the one in Wyoming?

David Berges

I’m sorry to say I’m not aware of it, or not...

Michael Lew – Needham & Co

Okay.

David Berges

I look at the Vestas’ announced orders and Vestas’ backlog principally. And I have not seen any announcements in this quarter from Vestas on U.S. orders, if you know of one, I’m happy to hear about it.

Michael Lew – Needham & Co

Well I’d say they were one of the potential suppliers that’s been named, nothing’s been confirmed yet, but Mike and Bob.

David Berges

And we’re one of the potential providers of the raw materials.

Michael Lew – Needham & Co

If you work with Vestas right. And then just one final question on the wind space, I mean wind energy space, what’s your long-term view on it, do you expect it to eventually recover, do you have more customers in the pipeline that could be announced over the next year or so?

David Berges

We work with a number of customers. The one that drives the top-line, though, and is easiest to point to for understanding of our outlook is generally Vestas They still have a very strong backlog. They have lowered however their forecast for 2013 from what their projection is of production this year. So I think all of us that support the wind markets are sort of preparing ourselves for little bit of a slowdown, perhaps even a pullback. Long term I’m not sure your definition of long but I do still think the wind energy business is a very good long-term market, industry and will, five to ten years, from now still be a strong part of the mix in energy.

Michael Lew – Needham & Co

Okay, well thank you.

David Berges

Sure.

Operator

And we will take our next question Ken Herbert with Imperial Capital.

Ken Herbert – Imperial Capital

Hi, good morning.

David Berges

Hi, Ken.

Ken Herbert – Imperial Capital

First just wanted to ask with the strong growth on the commercial aerospace side from the new programs, can you provide a little more color on the mix within that? I mean it seems like A380 was maybe flat at best and probably some more pressure there, but was the growth really 787 or you are starting to see other programs like the A350 in particular step up as well?

David Berges

I think in general the A380 has been the leader over the last six quarters or so. It did, as you suggest, taper off as they’ve modified their build rate projections. So I would – it’s hard to separate seasonality and the wing repair work that they’re doing from the trends, but I think it would be safe to say the A380 is probably going to level out at its current level, though it has been strong for a number of quarters.

The 787 had a lull a year ago that lasted about four quarters as the delay was observed in the supply chain, and is now ramping pretty nicely. We think we’re generally in the right level trend wise on each of the programs by the current numbers; it’s hard to tell on a new program exactly what our sales should be with so many ship-tos and yields ill defined. But right now we think the growth that you’re seeing is appropriate for the current build rates.

Ken Herbert – Imperial Capital

Okay that’s great. And just one follow up on the 787, you’re running then, I’m assuming for a quarter or two, in anticipation of the five-a-month build rate? And as that continues to step up into 2013 are you expecting to follow that part or are there any inventory issues that you’re aware of specifically on the 787?

David Berges

I expect that we should follow that path. There can be all sorts of things that go on under the covers with inventory but right now I think we’re on the right pace. We obviously have been supporting the five-rate that you’re talking about for some time now because we tend to be on average six months ahead of our customer ship date. So we’re working down on five.

Ken Herbert – Imperial Capital

Okay, that’s great, thanks Dave. And if I could just one quick follow up on the wind market. I mean clearly a bit of a step back in the quarter and I think we, without pushing on a 2013 outlook I’d ask you a similar question, Vestas your customer there doesn’t have necessarily the best track record in terms of sort of their inventory management. And you’re looking at a step down in their shipments in 2013 based on their latest guidance. Is there any concerns we should have about inventory in sort of your shipments into Vestas as volumes potentially step down? Or are you feeling good again about at least inventory levels and that part of the business with your customer on the wind side?

David Berges

Well our particular inventory is pretty tightly controlled between our plant and the blade making plants, because the volumes are pretty significant. Whether they get ahead on the inventory of their finished blades is something that’s a little beyond our control. But over the years of working, and particularly in the areas where we have factories very close to their assembly plants, I think we’re in pretty close coordination and I don’t expect to see big inventory swings.

Ken Herbert – Imperial Capital

Okay that’s helpful, thank you very much.

Operator

And we will take our next question from Peter Cozzone with KeyBanc Capital Markets.

Peter Cozzone – KeyBanc Capital Markets

Good morning guys, great quarter.

David Berges

Hi Peter, thanks.

Peter Cozzone – KeyBanc Capital Markets

A competitor of yours recently noted some temporary destocking in the commercial platforms. Now you touched on it a bit I think but it sounds like you believe inventories are at appropriate levels now across the supply chain? Could you just may be talk a little bit more about your visibility further down the supply chain?

David Berges

Well we try to stay pretty close and paid pretty close attention. We did in a number of prior quarters point out that shipments for legacy aircraft seem to be running ahead of what line rates would suggest. But I always assumed that to be a restocking effort over the 2009 pullback, which I thought was a destocking. Our current sales seem to be in line with the announced rate so I would maybe say that restocking is perhaps complete rather than destocking underway at least with our customers as far as we can see. So I think barring any year-end inventory seasonality we should be tracking more closely with build rates going forward.

Peter Cozzone – KeyBanc Capital Markets

And then similar question as far – in regard to the JSF I mean we talked little bit about slowdown there earlier this year, has that activity largely ended as we enter the fourth quarter here?

David Berges

I am not sure what slowdown you’re referring to. We provide the fiber to a competitor who makes the prepregs. So we monitor their output pretty closely and there has been little bit of – that has not been a smooth and even trend just because of campaigns that are run. But it’s not a big, big part of our total mix as of yet and we still think incrementally the Joint Strike Fighter is going to be a contributor going forward.

Peter Cozzone – KeyBanc Capital Markets

Great. And then just one more if I may. In terms of incremental margins you seem to be tracking well above your 20% long-term target for 2012 and some better execution. Looking towards 2013, is there any reason or headwind that you might not be able to at least see incremental margins in that range, assuming commercial aerospace production rates continues a steady ramp and then it seems that some of your upfront qualification costs are winding down here?

David Berges

Well, we always have headwinds and occasionally we get a tailwind but I’m not sure what you mean by in that range. If in that range you mean over 20% as is our target, yes, I do expect we’re going to continue in that range. If you mean our year-to-date range, I hope so but that’s not our guidance at this stage; we’ll let you know in December.

Peter Cozzone – KeyBanc Capital Markets

Great, thank you very much.

David Berges

Sure.

Operator

And we’ll take our next question from Kristine Liwag with Bank of America Merrill Lynch. Please go ahead ma’am.

Kristine Liwag – Bank of America Merrill Lynch

Hi yeah the government fiscal year started October –

David Berges

Kristine we lost you, if you’re still there.

Kristine Liwag – Bank of America Merrill Lynch

Hello?

David Berges

Kristine?

Kristine Liwag – Bank of America Merrill Lynch

Hi. Oh can you hear me now?

David Berges

Yes, we can.

Kristine Liwag – Bank of America Merrill Lynch

All right, great, I feel like I was in a commercial

David Berges

Did you ask a real tough question?

Kristine Liwag – Bank of America Merrill Lynch

Well I guess I can start again so I can make it tougher. The government fiscal year started in October 1, and the DoD is operating in a continuing resolution again. Are you seeing any changes in order activity from the customer at this time?

David Berges

We’re so far down the supply chain that we don’t have a short cycle reaction like – that would – we’d be able to distinguish. We’re still going pretty strong particularly in the helicopter business and rotorcraft business. A lot of that is increasingly coming from civil helicopter sales, which I remind you we report in the same space and defense segment because we can’t really separate it out. Oil exploration, executive travel, emergency medical services, search and rescue are all putting good demand on the helicopter providers. We also have a very heavy participation in the European defense business and Asia for that matter. So I still don’t expect to see a big downdraft in space and defense just because of some domestic program slowing.

Kristine Liwag – Bank of America Merrill Lynch

Sure. And then I guess the other part – I know you guys have a pretty big exposure to the V-22 as well. Has the customer provided any sort of guidance on how to deal with sequestration if it were to happen? I mean as we get closer to January 2 it seems like the risk keeps going up right?

David Berges

Well I heard Mr. – Governor Romney last night saying he’s going to increase defense spending and President Obama saying sequestration wasn’t going to happen. But at the end of the day we’re supporting our customer’s demands and C-17 is an important program for us but has a number of important orders including foreign military sales. And while we do see some softening over time it’s not enough to tick us off of our growth trajectory on space and defense. In fact the A400M transport will probably more than cover anything of the C-17 if in fact it ever does end.

Michael Bacal

V-22...

David Berges

I’m sorry V-22, was that the question? Oh, missed that one entirely. The V-22 we are aware of the step down schedule from multiyear procurement that I understand would be more expensive to cancel than to continue with. But again I think these other the programs are going to help us fill that gap just like we filled the gap of the termination of the F-22 and earlier programs.

Kristine Liwag – Bank of America Merrill Lynch

Sure.

David Berges

Thanks, Mike.

Kristine Liwag – Bank of America Merrill Lynch

And I guess I’m switching gears, can you talk about opportunities for further IM fiber use in industrials?

David Berges

We don’t have anything large enough to draw attention to at this time. intermediate modulus fiber is the premier fiber for the most difficult of applications and in the industrial world there are areas where it is and can be used, but it’s not of a significant enough volume that its worth lot of time on.

Kristine Liwag – Bank of America Merrill Lynch

Sure, I mean I think you guys are in the Lamborghinis, but are there opportunities for other maybe luxury cars but in that category? Let’s say a step down like Mercedes, BMW or anything like that? Or is that still not a use for IM fiber?

David Berges

There are a few applications that take our best fibers but they tend to be more in Formula 1 and such. There are a lot of improvements that can be made on Lamborghini and other cars with high strength fiber and industrial fibers if they can afford the premium. And we do participate in those markets, but again it’s nothing significant enough that we would be investing additional capital on.

Kristine Liwag – Bank of America Merrill Lynch

Great, thank you.

Operator

And we will take our next question from Noah Poponak with Goldman Sachs.

Noah Poponak – Goldman Sachs

Hi. Good morning, everybody.

David Berges

Hi.

Noah Poponak – Goldman Sachs

You’ve highlighted the other bucket in aerospace where you house regional jet, business jet as flat on a year-over-year basis but down sequentially. Can you just maybe parse that out a little in terms of the specific programs that are driving a sequential decline there?

David Berges

Well, I don’t know exactly about sequential decline but just generally let me say that regional jets, not surprisingly, are struggling and large business jets are contributing. So, the larger business jets such as the new Gulfstream, Dassault, Embraer and Bombardier business jets, the larger class aircraft seem to be doing pretty well and they have increasing composite content. So those are contributors and the all other beneath those, small jets, of course Hawker, and regional jets, are suffering.

Noah Poponak – Goldman Sachs

Okay. So the – but the regional jet manufacturers are pulling product from you slower now than they were three, six, nine months ago?

David Berges

I don’t have that in front of me but I’d be stunned if they aren’t because that business – the demand is certainly down and build rates are not going up. I would say it’s down a little bit, what Wayne tells me.

Noah Poponak – Goldman Sachs

Right. Okay. You touched on the productivity and cycle time improvement component of the CapEx reduction. The other part of that sentence in the release is your latest demand model. Can you just elaborate on what specifically you’re referring to there as it relates to the CapEx reduction?

David Berges

Well, the big driver as I said before is we’re not carbon fiber specified. So I think we try to track all of the programs just like you do at a top line and we try to do it on that carbon fiber style and type – pound per pound per pound, because we want to get the capital right. So we have a big complex model that tries to track everything that uses our fiber and we rerun it regularly and then we make a review about when we’re going to start the next tranche of capacity expansion or when we’re going to fire up and hire on the capital that’s spend deployed. So it’s (inaudible).

Noah Poponak – Goldman Sachs

Right, but any noticeable change in any specific programs or aircraft type embedded in that? Or sort of just you put it all together and this time it was a little lower than before?

David Berges

Well, some are up and some are down. Engines – our engine support is up with the new engines coming on line, those that use our fiber. USEC is still out there but clearly delayed; if it gets funded we’ll have support that but we’ve taken a lot of our 2013 requirements. And the Joint Strike Fighter build rates are less than what we’ve envisioned two or three years ago. The A350 announced a three month delay this summer. So I mean those are some specifics on the downside and the upside jet engines and` A400M and some other programs are a little more upside than what we had anticipated.

Noah Poponak – Goldman Sachs

Okay. And then just one last one. Is there a step up in the tax rate in the fourth quarter relative to where it’s been trending year-to-date?

Wayne Pensky

No, no they – we’ve got the year-to-date rate at 31.6% and that’s where we expect to end up. So there’s a minor drop in the third quarter to get it down to the 31.6% but that’s where we expect to end the fourth quarter.

Noah Poponak – Goldman Sachs

Okay, thank you.

Operator

And we will take our final question from Avinash Kant with DA Davidson & Co.

Avinash Kant – DA Davidson

Good morning Dave and Wayne.

David Berges

Hi Avinash.

Avinash Kant – DA Davidson

Maybe you talked about this one, but could you give us some qualitative understanding of how to think of the wind business in the fourth quarter? It was down significantly this quarter, but in your guidance what are you thinking about?

David Berges

I think that we’ll see continued softness in the U.S., and I don’t have a number for you but in our guidance if you backwards calculate what the fourth quarter looks like, it looks a little softer than you might expect if wind were growing at the pace that it has been growing. So we see aerospace continuing to growth nicely in the fourth quarter, but we’ve put a little caution into the industrial outlook.

Avinash Kant – DA Davidson

Right, and actually my second question was on that too. Looks like ex the wind business your industrial business actually was up sequentially. Given all the negative news that is out there on the industrial side, do you still see that business doing – staying at a similar level in Q4 compared to Q3?

Wayne Pensky

I would just – yeah, Avinash I would view that in constant currency, I’d view the industrial business as generally flat.

Avinash Kant – DA Davidson

So on a sequential basis Q4 –

Wayne Pensky

I’m sorry, excuse me, outside of wind just be clear.

Avinash Kant – DA Davidson

Outside of wind could be flat sequentially versus wind could even go down further in Q4 little bit?

Wayne Pensky

Yeah, if you look at our implied guidance that would be reasonable conclusion.

Avinash Kant – DA Davidson

Perfect. Thank you so much.

David Berges

Sure. Okay. Operator, I think we’re finished. Thanks very much.

Operator

Thank you. That does conclude today’s conference. We do thank you for your participation.

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