Wayne Pensky - CFO Nick Stanage - Chairman, President & CEO.

Myles Walton - Deutsche Bank Gautam Khanna - Cowen & Company Mike Sison - KeyBanc Robert Stallard - Vertical Research Ken Herbert - Canaccord Greg Konrad - Jefferies Ron Epstein - Bank of America Merrill Lynch David Strauss - UBS.

Good day everyone and welcome to today’s Hexcel Corporation 2016 Fourth Quarter and Full Year Earnings Conference Call. Just as a reminder, 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 call over to Mr. Pensky. Please go ahead, sir..

Hi, thanks. Good morning, everyone. Welcome to Hexcel Corporation’s fourth quarter 2016 earnings conference call on January 26, 2017. 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 recorded or rebroadcasted without our expressed 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 the call is to review our fourth quarter and full year 2016 results detailed in our press release issued yesterday. Now, let me turn the call over to Nick..

Thanks, Wayne. Good morning, everyone, and thank you for joining us today. As you have seen in the last night’s release, we had a strong fourth quarter with sales of $484 million, 4.6% above our fourth quarter 2015 sales in constant currency. Our key growth programs remain on-track and performed as expected.

Our operations continue to perform well delivering strong fourth quarter operating income of $87 million with a healthy operating income margin of 18%. Our adjusted diluted EPS of $0.64 provided a strong end to 2016, which was yet another record year for Hexcel.

For the full year 2016 revenues were $2 billion a landmark for the Company and sales were up 7.9% above 2015 in constant currency. Our adjusted diluted EPS for the year is $2.58, 11.2% above 2015. Full year free cash flow was $73 million, exceeding our initial guidance range of $20 million to $60 million.

In fact, our cash from operating activities was more than $400 million by far our highest in history. Now, let met briefly provide more detail on our markets. As usual, I'll discuss year-over-year comparisons in constant currency.

As you're aware currency movements influence our reported results and some of this impact is not intuitive, but the bottom line is that when the dollar strengthens against the euro and the British pound, our sales translate lower while our income increases resulting in higher margin percentages.

Commercial Aerospace now accounts for 71% of our total sales and for the quarter these sales increased 7.6% versus 2015. Total revenue from new Airbus and Boeing programs, which include the 787, A350, A320neo and 737 MAX increased nearly 40% in the quarter as compared to last year, driven by the A350 and the narrowbodies.

For the full year commercial aerospace sales were 11.3% higher than 2015 with new program sales increasing more than 40%. Airbus and Boeing sales for legacy programs declined year-over-year by 8%.

As mentioned during last quarter's earning call, we're going to stop calling out new programs and legacy program sales going forward as the transition from legacy platforms to derivatives and new programs make this distinction no longer practical or meaningful.

Sales to other commercial aerospace which includes regional and business aircraft were just above last year's fourth quarter and slightly lower for the full year comparison. Space & Defense sales for the quarter were $79 million, down 4.2% as compared to the fourth quarter of last year. For the full year 2016 were 4.6% lower than 2015.

The decline for both the quarter and the year is driven by reduced rotorcraft sales. Rotorcraft now accounts for just more than 50% of Space & Defense sales with more than 85% coming from military sales as commercial rotorcraft sales have significantly declined in recent years.

As you recall, we went into 2016 expecting Space & Defense to hold at the same level as 2015. We identified fairly early in 2016 that this was going to be challenging and from that point the year unfolded as expected. The difference boiled down to two key areas.

First, we saw some customer supply chain adjustments on the A400M, and second was the further reductions in helicopter programs from both lower blade orders and lower commercial helicopter demand, and this was at Sikorsky, Airbus and AgustaWestland.

As a reminder, we have diverse and broad range of products on more than 100 programs in the U.S., Europe, and Asia including rotorcraft, transport, fixed wing and satellite programs. Industrial markets sales for the fourth quarter were $54 million, which was comparable with the fourth quarter of 2015.

Wind energy sales were about 10% lower as compared to quarter four 2015. For the full year, our industrial sales were 7.4% above 2015 with wind energy sales at the same level as 2015. The rest of the growth we saw in the year came from our acquisition of Formax which was partially offset by lower recreation and other industrial submarket.

Now, let me turn the call over to Wayne to discuss some of the quarter’s financial details..

Thanks Nick. For the quarter, gross margin was a strong 28% as compared to 27.5% in the fourth quarter of 2015. For full year gross margin was 28.2% compared to 28.6% as all period reflect strong operating performance. 2016 witnessed the start-up of several new production lines in the year for district capacity to support our forecast to grow.

Importantly, depreciation and amortization continued on a planned ramp coming in $18 million higher for the full year than 2015 on a constant currency basis. Exchange rates had nominal favorable impact on the fourth quarter gross margin as compared to the fourth quarter of 2015.

For the quarter, SG&A expenses of $36.5 million or 2% higher than the fourth quarter of 2015. For the full year SG&A expenses were $158 million just 1% higher than 2015. Research and technology expenses were $1 million higher than last year’s fourth quarter.

For the full year, R&D expenses of $47 million were more than 10% higher in constant currency compared to 2015, as we continue to invest in innovations to support new technologies products and process development. For the quarter, our operating income as a percentage of sales was 18% as compared to 17.5% in 2015.

Adjusted operating income for the full year was $360 million 18% of sales as compared to 17.9% of sales in 2015. For the full year exchange rates contributed about 40 basis points to 2016’s operating income percentage as compared to 2015.

Our engineered product segment delivered 14% operating income margin for the quarter at the end of the year with a 12.7% operating income margin compared to the 13.6% margin in 2015. We do experience learning curve in this business as we startup new programs and replace material legacy programs as they wind down.

We’ll continue to work to optimize our margins in this increasingly competitive segment though 12% margin still produces a very attractive return on investment capital.

The effective tax rate for the fourth quarter was 27.9% reflecting end of the year adjustment to the full year effective tax rate relating to the final income mix by country, and lower deferred tax liabilities as a result of reduced future tax rate in certain countries.

The lower effective rate contributed $0.02 to our fourth quarter earnings per share as compared to our 30.5%. For the full year lower tax has helped our adjusted EPS by $0.06 as compared to our initial guidance. Excluding discreet items, the underlying effective tax rates 2016 and 2015 were 30% and 30.9% respectively.

We generated $73 million of free cash flow in 2016 compared to use of $4 million of cash in 2015. This result was driven by higher earning and lower usage of working capital partially offset by an increase in capital expenditures in 2016 to $328 million compared to the $305 million in 2015.

We have targeted to maintain our return on invested capital above 14% during the CapEx ramp up and please to say that our return on invested capital for 2016 was 14.4%. To our free cash flow and increased borrowing in the year, we spent $191 million.

This included repurchase of $111 million of shares under our authorized share repurchase program, $40 million on dividend and $30 million on investments in company. Reminder, we've brought the remaining 50% of Formax last January and then we made three investments in innovative companies that had a promising technology.

We have $93 million remaining under our authorized share program. Now, let me turn it over to Nick for some final thoughts before we take your questions..

Thanks, Wayne. 2016 was another record year for Hexcel, demonstrating that we continue to execute on plan. The outlook for growth in our Commercial Aerospace market remains strong, thanks to our positions in our new programs such as the A350, the A320neo and the 737 MAX.

We recently provided guidance for 2017 and beyond and continued to have very high confidence in our positive outlook for the Company. Our guidance for 2017 has an EPS range of $2.64 to $2.76 based on sales in the range of $2.05 billion to $2.15 billion. We're also projecting free cash flow for 2017 of more than $100 million.

Thanks, and we'd now be happy to take your questions..

Thank you. [Operator Instructions] We'll go first to Myles Walton of Deutsche Bank. Please go ahead..

I have a question for you on cash to construction there. So 400 million of operating cash flow is pretty great, but the guidance for '17 is also right around 400 with lower CapEx dropping through. The question is, in terms of working capital accounts, inventories, first time in while where you had a source of cash.

Is that going to be a level of trend and given the cash performance you saw at 400 million? Is the 400 million guidance for '17 now looking maybe a little conservative?.

Myles, let me give you clue that might help a little bit. We're expecting an increase in cash taxes in 2017. Now, we actually did quite well in 2016 and some of that got pushed out, and that is the way we stand out at about $30 million or which reduces our cash by about $30 million. With respect to inventories, we did well in 2016.

To recall, if you go back to 2015, we probably carried a little bit more inventory we liked partly as we went through the New Year, the implementation amongst other things. We've been able to get it down, but as we looked out going forward we probably always carry a little bit more inventory that perhaps we like.

But our first priority is to meet customer commitment. So, I doubt if we can improve that but we'll still try..

Okay. And then maybe at a higher level, the underlying pull that you're seeing from your customers in the commercial side. I imagine the 350 from what Airbus was talking about, is still consistent with your plan.

I am just curious on some of the other wide bodies where there have been pushes and pulls, or mostly pushes in the production rates lower in the mature programs, are you sensing or seeing any destocking negatively, versus what you would otherwise expect given the production right now?.

Yes, Myles, so let me start with the 350. We ended the year '16 running at about seven per month, and as you know Airbus has communicated that there're going to be at 10 per month by the end of 2018. So, we remain on track there and see steady increase throughout the year projected for this year.

The one item that stands out little bit with the late announcement that Boeing made on the 777. We had anticipated the reduction in the rate. They in essence pulled it in the little quicker than we expected. We’re going through that we also expect a little supply chain tightening on that program.

So, we see a headwind on that program probably in the neighborhood of 15 million maybe 18 million. Other than that we had anticipated pretty much all the current white body reductions that have been talked about and supply chain adjustments that have been talked about..

Gautam Khanna of Cowen & Company has the next question..

Wanted to get your sense of the cadence through the year of earnings, and if you could remind us of what we should expect seasonally, and given your comments on the 777, and some of the other rate perturbations, how that seasonality might be impacted by these changes? Any sort of color on earnings progression?.

So, Gautam, in general we give annual guidance not quarter-by-quarter guys, but just a few points, remember, just mechanically how we recourse compensation expense is higher than first quarter than the other quarters. But generally, I think you’ll see the first quarter about $0.06 lower than the other quarter.

In addition, second quarter usually tends to, all thing being equal maybe little bit higher than the other quarters. You see the third quarter got summer in Europe. In the fourth quarter, you’ve always got yearend. So, we tend to have a little bit higher first half than second half, all things being equal.

But other than that's something to point out at the moment..

Okay. That's helpful. And then, within industrial I remember you guided wind down a little bit at the December update.

What's the latest here for that, what do you think happens to that business given all of the discussion on the PTC? Are we going to see declines for a couple of years, or how does this actually play out in the marketplace?.

So, as you mentioned, we do see 2017 being a little softer for us specifically because of blade changeovers and mix. Given the positions we are on, we fully expect to rebound in 2018 and even above 2016 levels.

So we still from what we feel good about wind and the efficiency that the blades and new turbines are generating and their ability to compete with other energy sources. Now, with the new political landscape might bring, we continue to monitor that.

Obviously, there is a lot of things being talked about globally, I can tell you we are doing pretty significant scenario planning across the board and what could happen, what could influenced headwind, what could offer tailwind with respect to business opportunities import, export or tax.

So, we are just monitoring at real time maintaining our flexibility, so that we can adjust and take advantage..

Thanks for that..

The only thing I'd add just to remember the America is maybe a fourth of our wind business..

One last one just on the M&A pipeline, what types of things are you looking to add, and if you have any sense for what are the, are there any big assets out there that could actually really help the portfolio, or are these going to be more tuck-in acquisitions as we've seen with Formax?.

I think what you've seen us do with respect to Formax and strategic investments in OPM and Luminati and recently in December with carbon conversions are going to be similar going forward.

We're really aligning with our strategic plan and that is to enhance our core advanced composite material position with technologies that allow us to offer our customers more innovation, broader system or maybe vertical integration of our existing space. So, I don't expect anything massive, but we have an active pipeline..

And next from KeyBanc, we'll hear from Mike Sison..

I want to understand the A350 a little bit. When you think about the growth for you, you should see good growth in the first half of 2017.

But then in the second half of 2017, does that growth rate kind of flatten out, and then when Airbus ramps up to 10, is that more of a first half of 2018 impact on you?.

So, first off, we remain excited certainly with the performance of Airbus on the program. I'm very excited to see that they delivered pretty much on their plan or at 49, A350s last year. We'd expect that ramp to continue.

Having said that Mike, we ended the year at seven, we're going to increase steadily through the year and it's really not our position to give any more definitive guidelines on the specific rates that we expect Airbus to be. But it'll be a gradual ramp between now and the end of 2018 to hit the cannon and we feel good about that..

On Space & Defense, when you think about all the moving parts, do you feel it's bottomed to some degree? Does sound like the new administration wants to increase whatever military strength in the U.S. here.

When you talk to your customers, is that a positive potentially, as you think about through the end of the decade?.

I certainly see it.

We see it as a positive potential and if you look at the programs we're on and the platforms we're on and the continue secular penetration with things like the JSF bound to grow as you know '16 was relatively flat, as Lockheed didn't get out the number of plans they intended, a great platform for us which will be our biggest program.

We track commercial rotorcrafts in that segment. I still hope we're close to the triumph, I've seen indications and others in the industry have said that they think maybe we're, having said that I don't see a big rebound in 2017, but down the road I think it'll be a tailwind.

And then again just the new positions we've on programs like the CH-53K, the continued strength on the A400M and the V-22, we still feel good and I'll stand with our 3% to 5% long term growth in this segment..

[Operator Instructions] We'll go next to Robert Stallard with Vertical Research. Please go ahead..

Wayne, I got a quick question for you.

First of all, on the CapEx, how do you see the additions capacity tracking over the course of the year? And when do you expect the Moroccan facility to come online?.

So, Morocco is -- I’m just drawing a blank..

Yes, we are going to do grand opening midyear and we are actually producing out of the temporary location as we speak..

Okay.

Normally on the new capacity that you are putting in place, what sort of utilization are you expecting in these facilities as you go through this year and maybe into next year as well?.

Well, some of that as we got through the process. We have to get the lines qualified and so what happens during the course of qualification is viewed either expect that the products you make while you waiting to qualify will be qualified. And therefore, you build up inventory little bit or you run them at a slightly lower rate.

So particularly on the carbon fiber line and remember the carbon fiber line in France will also startup this year. We will try to run them 24x7 as much as we can, but in terms of how they ramp up during the year, but probably our CapEx spends probably little more this year in terms of first half of year second half..

As a related issue, yesterday Boeing was talking again about moving the 787 up to 14 a month.

How does your capacity look relative to that potential rate, and if they do pull the trigger, how much lead time do you need?.

So first of fall they are talking about the end of decade, if I read it right. So, we’ll have plenty of warning. We don’t have that much carbon fiber on a lot of those programs. I think there is some particularly, but I suspect we will get plenty of warning shots..

We will go next to Ken Herbert of Canaccord. Please go ahead..

Hi, Nick. I just wanted to follow up from the Investor Day, one of the comments you made was it sounds like you're seeing a significant step-up in sales from 2017 to 2018. I think you mentioned double digit growth. And it looks like with the A350, you're probably ending maybe this year at who knows, 8-ish, 9-ish a month, on your way to 10.

Is it fair to say commercial aerospace from '17 to '18, it's really about the Max, and the Neo, and the narrow body ramp, that drives much of that upside or anymore detail to bridge that '17 to '18? I know we're getting ahead of ourselves a little bit.

But I think there is still a fair amount of uncertainty around that step up, as you sort of see an acceleration in sales coming out of 2017?.

Yes, I think you hit the big ones, Ken. It's the narrowbodies for sure, the NEO, the MAX, but the A350 will contribute as well in 2018 as well as 2017. Those are the key drivers and then we have lots of other small movers that help drive the growth as well. So, those will make difference..

So 787, because theoretically end of decade you may have started to see part of that from ’12 to ’14 that really was in part of your acceleration in ’18 assumptions then..

That’s absolutely correct..

That’s right..

Okay, okay. That’s helpful..

If that pull the end given our shift time that could be a little tailwind towards the end of the year..

Right, and actually when we gave a 2020 guidance we expect the assumption was 12, 787 per month..

That's great. And then this year for '17, I just wanted to circle back once more on space and defense. I mean last year a little weaker certainly than the initial expectations. I think sentiment is clearly looking that it could be a little better this year. I know obviously military Rotorcraft.

Can you give a little more detail on the growth you're seeing in '17 on some of the major programs, specifically the 400 M, and the V22, and the Blackhawk?.

Well, we typically don't get specific on the programs, again given that we're on the 100 programs, given the fact that historically it's been very lumpy with respect to order patterns and how those orders fall through based on budgeting.

So, again we see puts and takes, JSF certainly is one of the high points, but other than that I don't want to get into what's going to go down a little bit, what's going to go up a little bit, it's really mix and timing..

Moving on to Jefferies, we'll hear from Greg Konrad..

Just wanted to touch on engineered products and you talked about it a little bit at the beginning of the call, you had a really good margin in the quarter. You mentioned there are a lot of programs that are early on in the learning.

What type of margins do you think you can earn in that as some of these programs progress?.

Well, we're -- higher is better and we're always pushing. But anywhere in the 12 or 14, as this business used to even run higher than that, given the landscape, given the competitiveness, we feel real good in that range. But I'm never going to say I'm going to sell off for 12, we're always going to push to maximize and streamline our operations.

So, and the other thing I'd say is we target the type of product we go after, higher value, more complex, which justify higher margin then say a very simple standard build to print product. And that's what we look forward in that business..

And then just on the share count, I think the expectation is just to keep that flat year-over-year, I mean is that somewhat determined what acquisitions materialized throughout the year? And if that pipeline doesn't sell up, would we expect to see a share count down here or what?.

Greg, let me give a more complicated answer. So, we ended the year with the debt-to-EBITDA ratio of about 1.5 times, and we expect we want to hold it at that level and probably slightly increase it. The goal is to maintain it at 2.5 times. But as our earnings grow we're going to end up increasing our debt, and we expect for 2017 will increase our debt.

The question is what we're going to do with those proceeds? First priority is always to fund the organic growth business which we do on our own. Second is M&A, which you can't control. The third, by default return it to shareholders.

So, depending on how much we borrow and depending on how quick the other things happen, we will then buyback stock at some rate, and so we'll have to see how that develops, but if that happens, than our share count will obviously go down..

Next from Bank of America Merrill Lynch, Ron Epstein. Please go ahead. Your line is now open sir..

Couple of bigger picture questions for you.

Are you guys doing any advanced work on different technologies like things like cold cure, that could potentially be applied to a future generation narrowbody or something as such?.

So, I can tell you we've a large focus on new technologies, new innovations, disruptive type technologies, not only on the raw material science, but on the processing. As you know these cycles are very long and today we're working on aircraft that.

All probability will not get launched and/or have any meaningful production until the end of the next decade or even later. So we are not going to guess specific on the technologies, but I can say some of our external investments that we’ve made, that have been visible.

Some of the collaborations we are doing, some of the university work we are doing and obviously our growing R&D team her are focused on heavily on advanced technologies in the composite material space..

And then maybe another big picture question if I may. When 787s first started rolling off the line, essentially the fly to buy weight aren't carbon fiber, the OEs were buying a lot more fiber than they needed ultimately.

Have they gotten more efficient at how they're using fiber?.

Absolutely, the industry which is what you would expect and what we need is becoming much more efficient, and that opens up the entitlement and the potential to increase the amount of carbon content by flame.

So, scrap and usage has come down, but that just the benefit of a composite makes it more competitive and allows for even more growth going forward..

Okay. Okay. Interesting. And then would you expect, I guess when I was looking at, we saw 787 all carbon fiber, A350 all carbon fiber. Then 777X came bumping along, and carbon fiber weighing in, not carbon fiber fuselage.

Do you think that's setting up a new model going forward, or was that a simple because this is a derivative of a bigger airplane, they are just not--, do you know what I mean? I'm not articulating this well.

Is the formula going forward carbon fiber wings with aluminum tubes or is that specific to that airplane?.

I think both Airbus and Boeing communicated not that long ago that, they were going to focus on derivatives for time period no clean sheet designed. And the fact that you guess some derivatives with the NEOs coming out and the 777-X is not an all new airplane, is simply what drove the change there. They state with the aluminum fuselage.

They put the wing on. There is no question, the big benefit with respect to the amount of time and the amount of weight is biggest in the wing.

Having said that, the next new airplane I think will be heavily dominated by carbon fiber composite, the next new narrow body the question is will the two be aluminum or composite and that’s the challenge we have to win that position..

From UBS we'll hear from David Strauss..

Wayne, a question for you potential tax reform and all of the things that are floating around out there, how are you thinking about looking most so color of quarter adjustment tax?.

I got to decide whether I want to give my personal views, or Hexcel's views. Just to help set the stage, so our U.S. income is now a little bit less than half of our total worldwide income. When we’re talking about U.S. tax rate, it's a little bit less than half. The complexity of our U.S. tax code and multiplied that by the complexity of U.S.

tax accounting, the taxes unbelievably complex. And I think for us mostly if you can simplify that and always lower the rates, obviously that's a good thing, but it just depends on most of the phase. So, we're doing scenario planning, the most important thing probably in the short term is to how they handle repatriation.

And so, we need to make sure we understand what our unremitted earnings that are permanently invested. Make sure that number understand as well and what the impacts and how they might treat that. That's probably the biggest short-term item. With respect to border tax, personally I think its nuts, but we'll still try..

And then an update 777X where do you stand with that, opportunities on 777X?.

Obviously as the entry in the service get's closer. We're getting firmer understanding and what's there and what we're winning. It's still a little early. We've some programs. We're still bidding on. So just not quite ready to give the ship set content on that. Other than, it'll be above our legacy content of a 1 million..

Great.

And then last one for me, Wayne, just an update on currency and hedging, and how much of a tail wind you're looking this year '17 versus 2016 relative to EPS?.

So, we're going into 2017 about 80% hedge, the net impact is favorable versus '16. I think the guidance we gave you it's sort of that the favorable benefit basically offsets the start-up costs of our fiber line at France and Morocco engineered core facility there.

And so, the exposure we have rating at 20%, if you think about this way there is 5% movement. That’s probably $2.5 million impact on EBIT..

And how hedged are you on '18 at this point?.

I think it's in the 40% to 50% range. It's somewhere around there..

And ladies and gentlemen, that does conclude our conference for today. We thank you all for your participation. You may now disconnect..