Hexcel Earnings Call Nuggets: Lighter Margins and A350 Growth

Hexcel Corporation (NYSE:HXL) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Lighter Margins

John McNulty – Credit Suisse First Boston: Just a couple of quick questions. So, with regard to the margins, when we look at the Composite Materials segment or even the Engineered Products segment operating margins, despite the decent growth that we saw this quarter and actually through the year, your margins are lighter than they’ve been in over a year in each of the divisions. So, can you walk us through maybe some of the puts and takes on that? I know you highlighted R&D was up. Was that the bulk of the difference or were there other things that we should be thinking about?

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Wayne C. Pensky – SVP and CFO: John, if you look at Composite Materials we were 17.3% for the quarter and that did – all the increase in R&D spending happened in that segment. If you actually go back before the fourth quarter of 2011, we actually only had two other quarters in our history where we were above 17%. So the bar has been raised and we obviously acknowledge that. But in general, I wouldn’t say anything unusual in the quarter other than the R&D spending. With respect to Engineered Products, we are at 13.6% which is just little bit lower than our targets 14% to 16%. And we did hit it for the year at 14.5%. It’s much more labor intensive in that segment than material segment and they do have learning curve on new programs and sometimes they have one time catch-ups with the customers. So, it bounces around a little bit more than Composite Materials, but nothing more in particular.

John McNulty – Credit Suisse First Boston: And then on the Space and Defense business clearly came in better than what we were expecting and I think you called out the rotorcrafts being particularly strong and maybe some timing issues in terms of deliveries between India and China, can you quantify what that was and is that something that you pulled from the first quarter of 2013 or is this something more that was supposed to go out in the third quarter and actually just got pushed out a quarter instead?

David E. Berges – Chairman and CEO: The exports tend to be done in pretty big lumps and create some choppiness in our quarter-to-quarter. The fact that India and china both had export release clearances in the fourth quarter, you could maybe spread those over a couple of quarters, I would not call it a pull ahead for sure. The other thing though that is different in 2012 than 2011, is the A400M is starting to ramp. They’re close to certifying and starting to ship it. So, as you can imagine the whole supply chain has started a drum beat of growth. So, we haven’t talked about that a lot because it’s been a long time coming, but it’s starting to register.

A350 Growth

Amit Mehrotra – Deutsche Bank: Dave, first question on the A350, Airbus was out today reaffirming that it’s on track for first flight this year and first delivery next year, but if I remember correctly, I don’t think you’re looking or you’re baking in much A350 growth in your 2013 guidance. So, can you just help me reconcile the two given some of the longer lead times in the new programs?

David E. Berges – Chairman and CEO: I don’t remember saying we don’t expect A350 growth. We have had good A350 growth from the beginning. I think a lot of people have tried to take our projected run rate, multiple per airplane times the number of airplanes built and in the development phase for two or three years before that, it’s way more than that, as people are developing and breaking parts intentionally and yields are down, so we have had significant A350 sales for the last two or three years, had good growth second only to the 787 in 2012 and expect good growth next year and year after and year after.

Amit Mehrotra – Deutsche Bank: Just one follow-up. Can you just give us some color on the seasonality in the business this year? I mean, should we still expect the typical pattern of stronger first half or be more balanced or I mean, maybe sort of stronger second half just given some of the ramps on the 87 and A350?

David E. Berges – Chairman and CEO: Well, first let me jump to wind, because that’s probably the biggest year-over-year comparison thing you need to be careful of when you’re doing your modeling. Last year 2012, the first half of the year in wind was the strongest first half in our history. It was very strong. The fourth quarter run rate was about 30% lower than the first half run rate. So, wind as we moved up to the PTC cliff went down 15% in the third quarter, down 15% again in the fourth quarter. Now we delivered good numbers, we delivered record fourth quarter. So, I am not particularly worried about it, but as you’re modeling growth recognize that if that run rate continues as it probably will until the U.S. gets cranked up again, and there is more of a recovery going on in the rest of the world. You’ve got 30% delta, the comparisons for the first two quarters. So, just to make sure you factor that in. I wouldn’t call that seasonality. That’s a fact of life. I do think we’ll still get single-digit growth in space and defense even off of a very high quarter, but I mean a very high year, but remember when you get to the fourth quarter we’ve got a big step-up comp because of the export. Seasonally, we also always have a higher SG&A expense in the first quarter because that’s when we deal with variable equity long-term compensation. You can look at the history on that, otherwise SG&A bounces round, but shouldn’t be anything way out of whack with the current run rate and let me think what the seasonality win is. Always that margin in the second half were lower than the first half because of the number of days and European holidays and such, but generally that’s within two percentage points both on the gross and operating level.

Amit Mehrotra – Deutsche Bank: If I could just sneak one more and then I’ll hop off. In the December conference, you talked about potential M&A and I wanted to see how should we think about that from a timing perspective? I mean should we expect something in the near or mid-term, how active is the M&A pipeline and what sort of parameters are you looking at in terms of end-markets and even valuation?

David E. Berges – Chairman and CEO: Boy, that’s a lot of questions for sneaking one in. So, as we said in December we’re happy with our improved cash flow prospects. We have past, what we think, is the peak for the next three years on capital spending. Our cash from operations was up 36% this year. So, as capital spending moderates and we continue to grow and deliver operating cash, we’re going to have plenty of cash for both internal and potentially external growth or returning it to shareholders. We haven’t spelled out any specifics on M&A or any specific timing on M&A only to say that if there are targets that fit our strategy which is being a leader in advanced structural materials in markets that have growth and secular penetration with sustainable competitive advantage, I know it’s a mouthful, but we’re not currently planning to grow for the sake of growth or just build up the top line. We like the business model in the slop of our margin improvement leverage and intend to focus on primarily keeping that on track.