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Edited Transcript of HXL earnings conference call or presentation 24-Apr-19 1:00pm GMT

Q1 2019 Hexcel Corp Earnings Call

STAMFORD Apr 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Hexcel Corp earnings conference call or presentation Wednesday, April 24, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Nick L. Stanage

Hexcel Corporation - Chairman of the Board, President & CEO

* Patrick Joseph Winterlich

Hexcel Corporation - Executive VP & CFO

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Conference Call Participants

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* Christopher John Kapsch

Loop Capital Markets LLC, Research Division - MD

* Gautam J. Khanna

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* Gregory Arnold Konrad

Jefferies LLC, Research Division - Equity Analyst

* Hunter Kent Keay

Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense

* John Patrick McNulty

BMO Capital Markets Equity Research - Analyst

* Kenneth George Herbert

Canaccord Genuity Limited, Research Division - MD and Senior Aerospace & Defense Analyst

* Krishna Sinha

Vertical Research Partners, LLC - Analyst

* Kristine Tan Liwag

BofA Merrill Lynch, Research Division - VP

* Louis Harold Raffetto

UBS Investment Bank, Research Division - Equity Research Analyst of Aerospace and Defense

* Michael Joseph Sison

KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Emily, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hexcel Q1 2019 Earnings Call. (Operator Instructions) Thank you.

Patrick Winterlich, Chief Financial Officer, you may begin your conference.

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [2]

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Thank you. Good morning, everyone. Welcome to Hexcel Corporation's First Quarter 2019 Earnings Conference Call. 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 news release.

A replay of this call will be available on the Investor Relations page of our website.

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

With me today are Nick Stanage, our Chairman, CEO and President; and Kurt Goddard, our Vice President of Investor Relations. The purpose of the call is to review our first quarter 2019 results detailed in our news release issued yesterday.

Now let me turn the call over to Nick.

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [3]

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Thanks, Patrick. Good morning, everyone, and thank you for joining us as we share our first quarter results with you. It was a terrific start to the year and one of the strongest quarters in our history, especially for sales and earnings per share. It builds on our momentum and strengthens our confidence as we reaffirm our full year 2019 guidance that we shared with you in January. First let me highlight some of the results and Patrick will then provide more details on the numbers.

Sales in the quarter were $610 million, up 12.9% year-over-year and up almost 15% in constant currency. Diluted EPS was $0.84, which is an increase of 23.5% over the first quarter of 2018. We delivered first quarter operating income of $103 million, which is about 25% higher than last year and resulted in an operating income margin of 16.9% compared to 15.3% in Q1 2018.

Before I spend time on each of our markets, let me talk about a few factors that helped us deliver these results to our shareholders this quarter. First, many of the headwinds that challenged us in 2018 are now behind us and we are experiencing growth in all of our markets. Moreover, we are benefiting from the successful integrations of our acquisitions and from some of our newest assets at Roussillon and Morocco that are now qualified and contributing to our strong performance.

Yet none of these factors influenced our results the way our employees do. You've heard me say before how proud I am of our team and they continue to truly impress me when it comes to their commitment to operational excellence. Employee teams leverage each other's strengths to drive excellence throughout the business and generate cost savings through efficiencies and productivity improvements as well as drive innovations that will lead to enhanced margin quality in the months and years ahead.

Let me pause here to talk about something that is on everyone's mind and that is of course, the tragic loss of 346 lives in 2 crashes involving the Boeing 737MAX program. We extend our deepest sympathies to the families and friends of those who are grieving the loss of loved ones, who were on board Lion Air Flight 610 and Ethiopian Airlines Flight 302. These tragedies weigh heavily on us because we believe that nothing is more important than the absolute safety of those who put their trust in our industry to make air travel safe. Like every other program supplier, we are closely following the investigation and monitoring the news. We believe that it is clear that Boeing needs its entire supply base, including Hexcel, to stay capable and aligned with them and we intend to do just that.

As you already know, we have about $400,000 for 737MAX shipset, which includes materials for engines, nacelles and structures that we sell to a broad supply chain, including more than 1/3 of our MAX sales going to Tier 1 suppliers of Boeing. Boeing suppliers are great customers of ours and we will continue to meet their requirements while staying flexible and agile to respond to any changes in the demand profile in the months ahead.

As you would expect, we are running a range of potential scenarios to make sure we are prepared to support the 737MAX supply chain throughout this uncertain period as well as support the aircraft's return to service and anticipated ramp up. This is a complicated process as we are responding to multiple demand signals. For example, some key suppliers are publicly stating that they plan to continue producing at a rate of 52 per month, while on the other hand, Boeing has announced a temporary rate decrease to 42 planes per month starting now.

As of today, we have seen very little, if any, impact from Boeing's announced rate reduction. We will continue to meet all demands for Boeing 737MAX materials and if there are any reductions in demand throughout the supply chain, we are confident that we will be able to repurpose the vast majority of our manufacturing and material capacities to take advantage of other short-term commercial opportunities.

And just to reiterate, after taking into account the potential impact we see at this point in time for the 737MAX revenues in 2019, we have made no changes to our annual guidance based on the offsetting, broader market strength we see before us.

Now let me turn to our 3 primary markets. Commercial Aerospace sales in Q1 were $416 million, which reflected an increase of 8.6% or 9.6% in constant currency. Growth in the first quarter was particularly strong in the A320neo and Boeing 737MAX narrowbody programs, and the Airbus A350 and Boeing 787 widebody programs continue to generate strong sales.

Sales for Other Commercial Aerospace, which includes business and regional jets, continued to grow and were up 7% versus last year's Q1. In Space & Defense, we experienced a strong quarter with sales of $108 million, reflecting an increase of 19.6% or 21.8% in constant currency. Growth was driven primarily by the F-35 Joint Strike Fighter program along with continued strength in military rotorcraft. In addition, I'm pleased to report that this was the first quarter that includes sales revenue from our acquisition of ARC Technologies and the business performed well and delivered excellent results for our first quarter of ownership.

Finally, turning to Industrial, sales were $87 million for Q1, which is an increase of 28.7% or 36.8% in constant currency. We continue to benefit from strong demand in wind energy, which now represents more than 60% of our Industrial sales. In fact, wind sales were up 78% in constant currency, which reflects not only a ramp up that began in late 2018 but also increasing demand for composite materials for wind turbine blades.

Before I turn it back to Patrick, I'd like to share a few highlights from the quarter. In March, we announced that a joint research and development laboratory with Arkema will open this month. You may remember that about a year ago, we announced a strategic alliance with Arkema to develop thermoplastic composite solutions for the aerospace sector and that alliance is moving along very well. Hexcel and Arkema are both leading innovators in the growing market for aerospace thermoplastics and we are excited as we anticipate supplying products to customers for evaluation later this year.

Next, congratulations to our teams in Kent, Washington, Pottsville, Pennsylvania and Salt Lake City, Utah, who were recognized recently by Sikorsky with supplier elite status for our 2018 performance in achieving best-in-class, on-time delivery, cost and quality. This is another strong example of how our focus on operational excellence is positively impacting our customers.

Finally, I've already mentioned the acquisition of ARC Technologies, yet let me say a little more. As you will remember, we announced our intent to acquire the business in 2018 and then close the deal in January. Our teams are continuing to work closely together to ensure a smooth integration without disrupting the business and I believe our Space & Defense results this quarter are evidence that the process is going well.

In summary, we expect our results this year will demonstrate growth, cash generation and value creation for shareholders. In Commercial Aerospace, we expect high single-digit growth driven by the A350 at 10 per month and in the Boeing 787, which ramps to 14 this year. We expect another year of strong growth for the A320neo and the new Boeing 777X is expected to begin to contribute to our 2019 growth as it approaches its entry into service in 2020.

And again, I want to reassure you that we will remain extremely vigilant and flexible in our response to developments around the Boeing 737MAX program, and we remain confident in our ability to address the potential challenges we see and to deliver on our 2019 financial guidance. We expect double-digit sales growth in Space & Defense in 2019, driven by strong F-35 and military rotorcraft programs and with the addition of ARC Technologies' products to our portfolio. And we anticipate double-digit sales growth in the Industrial market for 2019, supported by another year of strong, double-digit growth for wind energy.

Let me say it again, I couldn't be any prouder of our team in how they executed this quarter to deliver performance and value to shareholders. Hexcel has leading positions and secular penetration opportunities in the market with strong backlogs and solid growth. And we are achieving our objectives by staying disciplined, by focusing on operational excellence, by investing in the future and by continually delivering on our commitments to customers.

Now let me turn the call over to Patrick to discuss more of the quarter's financial details.

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [4]

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Thank you, Nick. First quarter 2019 sales totaled $610 million, an increase of 12.9% year-over-year. Our diluted EPS for the first quarter was $0.84, an increase of 23.5% compared to the first quarter of 2018. Free cash flow for the first quarter was a use of $15 million, reflecting the working capital impact of sales growth and seasonal effects as we expected. This compares to free cash flow generated of $3 million in the first quarter of 2018.

I will now provide a review of our markets and as usual, these year-over-year comparisons are in constant currency. As a reminder, currency movements influence our reported results and some of this impact may not be intuitive. The majority of our sales is denominated in dollars. However, our cost base is a mix of dollars, euros and British pounds as we have a significant manufacturing presence in Europe. As a result, when the dollar weakens against the euro and the British pound, our sales translate higher but our costs also translate higher, resulting in a net headwind to margins. Accordingly, we prefer a strong dollar to a weak dollar. In terms of currency hedging, we employ a disciplined hedging strategy that layers in hedges over a 10-quarter horizon, leading to a smoothing impact on currency rate fluctuations.

Now turning to our first quarter market performance. Commercial Aerospace represented 68% of total first quarter sales. Commercial Aerospace sales of $416 million increased 9.6% compared to the first quarter of 2018. Space & Defense represented 18% of sales. For the first quarter, Space & Defense sales totaled $108 million, an increase of 21.8% from the same period in 2018.

Activity in the first quarter was broad-based as Hexcel material is on more than 100 different platforms. Note that the 2019 results included ARC Technologies, which we acquired in early 2019. Industrial comprised 14% of first quarter 2019 sales. Industrial revenues totaled $87 million, increasing 36.8% compared to the prior year period. The strength was driven by wind energy sales, which increased 78% year-over-year. We continue to forecast strong growth in wind energy sales in 2019 although the magnitude of growth will lessen on a comparative year-over-year basis as the adoption of the latest generation wind turbines driving this growth became more significant during the second half of 2018.

On a consolidated basis, gross margin for the first quarter was 27.4% compared to 26.4% in the first quarter of 2018. The year-over-year improvement reflects solid execution by the business, supported by the benefits of leveraging higher sales. Total depreciation expense increased $8.9 million in the first quarter of 2019 compared to the prior year period due to our continued capital investments, combined with a onetime action to accelerate depreciation on some obsolete tooling. Our guidance was for depreciation expense to increase $20 million in 2019 or a quarterly step up of roughly $5 million. We continue to forecast this level of annual increase, excluding the onetime action taken in the first quarter.

For the first quarter, selling, general and administrative expenses increased 6.7% year-over-year. We continue to leverage the benefits of growth as selling, general and administrative expenses represented 8.1% of total sales for the first quarter of 2019 compared to 8.6% of total sales in the first quarter of 2018. Research and technology expenses increased $1.1 million or 8% year-over-year. We continue to invest in innovation that supports new technologies and products as well as enhancing existing processes, both for our internal operations and for our customers.

For the first quarter, operating income increased 24.8% to $102.8 million or 16.9% of sales as compared to $82.4 million or 15.3% of sales for the first quarter of 2018. The year-over-year impact of exchange rates was favorable by approximately 50 basis points due to our currency hedging program.

The Composite Materials segment represented 83% of total sales and generated an operating income margin of 22.2% for the first quarter of 2019 as compared to a 19.6% margin in the prior-year period. The Engineered Products segment, which is comprised of our structures and engineered core businesses, represented 17% of total sales and generated an operating income margin of 12.1% for the first quarter of 2019, compared to a 10.4% margin in the first quarter of 2018. Note, our recent acquisition, ARC Technologies, is being reported within the Engineered Products segment. While the operating margin is lower than the Composite Material segment, Engineered Products requires a much lower level of investment, generating strong return on invested capital.

The effective tax rate for the first quarter of 2019 was 22.7%. We continue to forecast an underlying effective tax rate of 24% for the remaining quarters of 2019.

Working capital increased $78.4 million in 2019 to support strong sales growth, leading to a use of cash in the first quarter and a negative free cash flow of $15 million. Accounts receivable represented the majority of the increase in working capital. Capital expenditures were $57.5 million during the first quarter of 2019 compared to $45.3 million in the first quarter of 2018 on an accrual basis. Construction is continuing on schedule for the additional PAN and carbon fiber lines at our Decatur, Alabama facility, which we are adding to meet forecasted post-2020 growth.

We are continuing to target a gross debt to EBITDA leverage ratio of between 1.5 and 2x. At the end of the first quarter of 2019, our leverage ratio was 2.1x, with the increase reflecting the financing for the January 2019 acquisition of ARC Technologies. We expect to return to our target range of less than 2x within the next couple of quarters.

We repurchased approximately $11 million common stock during the first quarter of 2019 and have $374 million remaining under our share repurchase program. Our capital allocation priorities continue to be investing in organic growth, followed by targeted and disciplined M&A, and we remain committed to returning greater than 50% of our net income to shareholders through dividends and stock buybacks.

As Nick stated, our full year 2019 guidance is reaffirmed. We expect the first and second half of 2019 to be relatively balanced in relation to forecasted sales and adjusted diluted EPS, whereas forecasted free cash flow is expected to have the same profile as prior years, with stronger free cash flow in the second half compared to the first half of the year.

With that, let me turn the call back to Nick.

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [5]

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Thanks, Patrick. By staying aligned with customer demand while keeping costs under control and operational excellence at the forefront, we delivered a strong first quarter and we are on track to deliver our full year guidance. We continue to benefit from aircraft program ramp ups, continued secular adoption of advanced composites and strong demand as well as from our internal efforts to work more efficiently, continuously improve our processes, develop new and innovative products and position ourselves for growth. Our markets are strong, with continued long-term growth expected.

Our focus throughout 2019 will be to take every advantage of opportunities to grow and drive innovation and operational excellence to achieve strong and sustainable financial results, while continuing to create ongoing shareholder value. We will respond to any headwinds, including the Boeing 737MAX with decisive actions to mitigate any negative impacts.

Finally, we look forward to having several of you join us next month for our Investor Day. For those of you who are not joining us in person, we hope you'll join us via a webcast to hear several of our leaders share perspectives on our innovation and growth in their respective areas. After a morning of presentations and our tour, we will wrap up the day by outlining our growth expectations and providing our midterm guidance.

Thank you, again, for your time today. Emily, we are ready to take questions now so we'll turn it over to you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Gautam Khanna with Cowen and Company.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [2]

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I was wondering if you could provide some perspective on the 737MAX supply chain that you supply into -- that Hexcel supplies into, just how diverse it is, how many different suppliers and what sort of closed delivery -- delivered close to ultimate aircraft delivery versus much longer lead time? Any way to split it so we can maybe get a sense for any sort of risk down the road, if there is any destock where it could surface.

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [3]

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Yes. Certainly our supply chain on the 737MAX is nothing like it is for the A350. But having said that, it's still multiple ship-tos, not only to multiple Boeing sites, but Tier 1s and even further down the supply chain. What you have to keep in mind is we're shipping materials to support engines and obviously, we know that's the LEAP and we've seen publicly what their intent is, at least for the time being on their production schedule. We ship to plants at Boeing and others for nacelles, which basically follow the engine builds with respect to scheduling and the timing for assembly on to the airframe. And then we ship to the airframe, to Boeing sites directly, various matrix, products and components, subassemblies, subcomponents for the MAX program. So as we came into the year, we were at about 52 per month and as everyone knows, the intent was to ramp during the year up to 57. The second accident happened and there was a grounding and the supply chain continued to operate. As I mentioned, we have not seen any changes to our demand signals.

We certainly expect some specifically around the airframe. Those will adjust quicker from our perspective than engines and nacelles and various areas that may have been a little bit behind. So I think much of the supply base will use this time as a bit of a recovery, a bit of an opportunity to build some buffer stock, in anticipation that the regulators will approve the fix, the changes, the training that are being proposed and reviewed. And ultimately, the grounding will lift and production and deliveries will start back up to some ramp rate yet to be determined. So that's about the best, obviously, it's a moving investigation and everyone's monitoring it. Certainly, we are and we're just going to stay current on it and make sure we're supplying to not only Boeing but the Tier 1s based on their needs and what they plan to do relative to the MAX supply chain.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [4]

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That's helpful, Nick. As a follow-up, I was just wondering, you did mention there's stuff that's unique to the engine and nacelle versus the airframe. Is there any ballpark split you can give us in terms of how much goes to engine-related stuff versus airframe on the 737MAX, relative to the content you guys have described in the past? 2/3, 1/3, or?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [5]

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The engines and nacelles, I don't think we split it out exactly. But we certainly have fibers and prepregs going into engines and nacelles, and we've got significant amount of core and Acousti-Cap going into nacelles for the noise abatement. And then we also have our structures business, providing secondary structures, interior components. Some of that business ships directly to Boeing and to Boeing Winnipeg. So it is mixed, it's diversified. And again, those assets are very deployable and easy and can be changed over quickly if in fact we do see a signal that gives us the capacity to divert for other programs.

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Operator [6]

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Our next question comes from the line of Mike Sison with KeyBanc.

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Michael Joseph Sison, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [7]

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Nice start to the year. Nick, in terms of when can you maybe talk to us a little bit about the backlog that Vestas has? And given how fast the market has grown, can you maybe give us a thought of were you adding capacity to support the growth there and how much it would cost to add more if you need to?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [8]

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Yes. So first thing, and we've said it before, but wind turbines are getting more efficient. They're getting more efficient because the technology has improved, blades are getting longer, they're able to put the wind turbine farms in lower wind speed areas. And the bottom line of all this is energy cost generated from wind turbines has come down significantly, which is driving part of that demand. If you look at over the course of 2018, Vestas turbine backlog, both in dollars and gigawatts increased every single quarter. They ended the year at just short of EUR 12 billion of backlog or 15.6 gigawatts, Mike. So obviously, there's continued interest in the wind farms. Obviously, Vestas is well positioned, not just in the U.S. but outside the U.S. where they generate almost 70% of their wind turbine sales and we're well positioned with Vestas to continue taking advantage of that growth and penetration.

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Michael Joseph Sison, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [9]

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Got it. And then just one quick one on the MAX. Given that you supply 6 to 9 months ahead, if the supply chain does adjust, when should you feel it, I guess, if they actually -- if the whole supply chain does go down to 42?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [10]

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Well first thing I'd say, Mike, is on the 737MAX, the lead times are not that lengthy. They're shorter and especially in our [tent] and our structures business, they're much shorter. So I would think within 4 to 8 weeks, if there is a further delay or a demand signal on taking rates down for whatever area, whether it's engines, nacelles or structures, we would see that relatively quickly and would adjust relatively quickly.

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Operator [11]

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Your next question comes from the line of John McNulty with BMO Capital Markets.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [12]

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With regard to -- with the MAX headwind that you've got, I guess obviously, there were some offsets or some surprises relative to what you're expecting in 1Q to kind of help things go along. Can you kind of give us some color as to where those surprises were? And how you're thinking about those respective businesses as they progress throughout the year?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [13]

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Well, thanks for the question, John. I'd say there wasn't one in particular program that jumped out. It was pretty broad-based. Obviously, wind in our Industrial segment was strong but we have forecasted that. Space & Defense may be a little stronger than we had originally anticipated. ARC Technologies continues to perform very well and quite honestly was stronger in Q1 than we had expected. And then just continued strength on commercial aero, continued opportunities and sampling on incremental opportunities, relative to our fiber sales and thermoplastic opportunity. So again, it was pretty broad-based and you're exactly right. In our forecast and in our commitment and confidence in maintaining our guidance, we certainly have modeled in an impact -- a negative impact on the 737MAX. And based on what we see, that will be more than offset by the robust growth we're seeing in other aspects of the business.

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [14]

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Just to clarify, John, we did not see a negative impact on the 737 in the first quarter.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [15]

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Sure, sure. No, that's perfect. And then I guess as a follow-up, we had fielded, I guess, a bunch of questions on some of the acrylonitrile outages and obviously, you weathered them pretty well through the quarter. So I guess can you remind us or at least give us some color as to whether you're seeing any supply issues there and also how you're hedged with that because I know you've got a relatively new hedge program in place as well.

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [16]

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Yes. Sure, John. We haven't seen any supply issues, through our supplier has not been affected. We buy our acrylonitrile on a price formula related -- directly related to polypropylene, and I think as we have mentioned as sort of a surrogate, we are hedging propylene over an 8-quarter period now, which is going to smooth out the pricing in front of us. So we don't expect variances to guidance because of AN. So really, quite a good story on AN for us at the moment. No supply (technical difficulty) and no pricing surprises.

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Operator [17]

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Your next question comes from Ken Herbert with Canaccord.

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Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace & Defense Analyst [18]

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Nick and Patrick, you had really nice incremental margins in the first quarter, by my estimate about 29%. And I know, Nick, you alluded to the fact that a lot of the headwinds you faced last year, whether it be on AN pricing or wind resins and of course, the new facility ramp, you're no longer seeing this year. Is there anything in your assumptions that would imply sort of incremental margins step down from here? Or anything else we should be thinking about in the second, third or even the fourth quarter that we should keep in mind that could potentially impact this aside from obviously MAX uncertainty and broader cycle issues?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [19]

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Yes, Ken. So, again, there's one element that I want to make sure I emphasize and the headwinds you mentioned were all known and we've talked about them and most of them are behind us relative to raw material inputs and our startups and our sites, but our plants and our teams' focus on productivity and leveraging sales volume through our facilities now has been fantastic. And to answer your question, I would expect to see that momentum to continue with the strong top line growth, the position we're in with respect to our plants are up and running. We are not dealing with any startups today. We've got good coverage and protection on AN now with our hedging program that we implemented last year. I feel really good about where we stand today. Obviously, I can't predict the unknowns. Obviously, there will be some negative headwind based on the 737MAX program and how that plays out. But overall, we're feeling very good.

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Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace & Defense Analyst [20]

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Okay. That's great. And maybe at the risk of sort of putting words in your mouth, but it sounds like the strength you're seeing in the first quarter and through the year, I think Nick, you just said more than offsets your current assumptions around MAX. Is it fair to say that the lack of adjustment to the guidance for the full year just reflects the fact that obviously, we're just 1 quarter in but also, there still could be some risk around the MAX? Or how are you thinking about the full year guidance now with what you're seeing this quarter on the MAX?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [21]

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Well again, we feel really good about our guidance. It is just one quarter in. And certainly, with the MAX hanging out there, I just wasn't ready, we weren't ready to make a change at this point. Hopefully, next quarter, we'll have a different story for you and it will be along the same lines you saw this quarter.

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Operator [22]

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(Operator Instructions) Your next question comes from Hunter Keay with Wolfe Research.

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Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [23]

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Can you guys please help me understand how to think about partnering for success with the backdrop of this MAX issue? And this is a complicated question but basically, PFS was marketed as sort of a take guaranteed volumes in exchange for a little bit of price and here we are now with rate potentially not filling up as fast as everyone thought would be the case but you've signed these long-term agreements with Boeing under this PFS umbrella. How should we think about how you guys have altered your supply chain in the context of PFS relative to this sort of [MAC] clause situation, you might argue, that's occurred since then?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [24]

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Well, a couple of points there. First, it's very rare that we have a guaranteed volume. Again, remember, most of our materials are sole-sourced. So when we win the program, we get the program sales depending on what the end customer demand is. So really, there's no volume guarantees in here. PFS, you could call it PFS, you could call it GE's name, you could call it UTC's name, you could call it Airbus, productivity and cost improvement, we've been doing that forever and I would expect we have to continue to do that forever. So our focus is to take cost out of our supply chain, to take cost out of our factories and share that so that we can, A, help our customers meet their objectives and B, make them competitive so that they sell more airplanes or wind turbines to their ultimate end customer. So with respect to our contracts with any of our customers and Boeing included, we're going to continue to drive productivity and we're going to continue to provide part of that productivity as price improvement for them to incentivize further secular penetration and growth. And I don't see that changing. I don't see the MAX and what Boeing is going through changing that direction. And certainly, it's not changing how we're operating our business or our focus on operational excellence.

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Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [25]

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Okay. And then can you talk about the A220 for a second? Obviously, just to kind of dove tail to the prior comment you made about constantly driving out cost but can you first of all, at a high-level, remind me of your shipset content or overall exposure to 220 and just talk about if you're getting any pressure from Airbus to drive out incremental cost of late?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [26]

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Hunter, just to be clear, you said the 220? Or 320?

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Hunter Kent Keay, Wolfe Research, LLC - MD and Senior Analyst of Airlines, Aerospace & Defense [27]

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I'm talking about the 220. You have exposure to that program with some capacity, right?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [28]

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Yes, 220. So we have not provided our shipset content on the program. Obviously, we're working with Airbus. We were working with Bombardier before the deal with Airbus. We're looking at multiple opportunities to increase our content. It's not insignificant today but combined with the low volume monthly, we just haven't declared that yet and we're optimistic that we're going to expand our position. So as you could imagine, Airbus is working on cost out and they're looking at some broader-scale opportunities on materials they have in their supply chain to help them achieve their overall objectives. And as the plant and plane continues to grow and production starts with to ramp up in the U.S., we think we'll have a nice incremental opportunity to share on the 220.

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Operator [29]

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Your next question comes from the line of Greg Konrad with Jefferies.

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Gregory Arnold Konrad, Jefferies LLC, Research Division - Equity Analyst [30]

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Just 2 quick ones. One, this morning, Boeing announced that they were at the 14 a month rate on 787. Just as we think about the quarters going forward, is it safe to assume you felt that impact in Q1 up from the 12 a month rate?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [31]

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I can tell you we saw some impact in Q1, but believe we're going to see much bigger impact as the year progresses. So we certainly expect quarter 2 and the second half to ramp up more significantly for us on the 14 rate.

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Gregory Arnold Konrad, Jefferies LLC, Research Division - Equity Analyst [32]

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And then I mean, you've called out the F-35 but also that Space & Defense's over 100 programs, and I think you're secondary on the F-35. Is there any way to maybe frame the size of that program and kind of where you are in the ramp, given that the supply chain seems to be at many different rates?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [33]

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So, I mean, the F-35 is a big program for us and it's one of our top 3. V-22 remains a very strong program and we're seeing good signals that that's going to continue. And the A400M, which is another one of our big ones, it's held steady, okay, if you look at it sequentially or year-over-year. To really get into more detail on the F-35, I'd really defer to Lockheed and the information they provided in their call yesterday from Maryland or the day before. Obvious, a lot of interest in international demand. I know there is concern on the program with Turkey and there is concern on some of the potential declines in the U.S. Military, but overall, we see great strength there. We're continuing to see demand signals from our supply team that support JSF going up. So I think there's a lot of excitement that the JSF is going to continue to grow through the year and it's certainly on or ahead of our forecast.

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Operator [34]

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Your next question comes from the line of Krishna Sinha with Vertical Research.

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Krishna Sinha, Vertical Research Partners, LLC - Analyst [35]

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You mentioned earlier in your remarks that you have the ability to repurpose some capacity if indeed there is some MAX rate adjustments. But if that repurposing should occur, would that happen at the same sort of margin rate that you're getting on the MAX currently? Or will there be some puts and takes that you'll experience as you repurpose those lines just in regards to margins?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [36]

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Well, specifically, we're very -- our opportunities with our carbon fiber are continuing to go up. Demand is quite honestly one of the reasons why our sales growth this year is so strong. So repurposing fiber assets for another opportunity we have would be similar to MAX margins. It basically wouldn't be noticeable. If you look at honeycomb core, again, it's another area where our engineered core business is just growing significantly, even faster than we're able to put in some assets. So we would divert that honeycomb core very quickly, again, at comparable margins. And we've said it before. If you look in our aerospace business, the margins are comparable. Where you have differences are if you transition and look into our wind business. And I can tell you, none of these assets would be redeployed to support wind or the wind turbine business. So overall, from a fibers, from an engineered core, from a matrix, very quick and easy to sell that where demand is strong. A little bit harder on the structures business, harder to backfill that and it would take a little longer, but it's just a portion of the MAX's overall shipset value we sell.

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Krishna Sinha, Vertical Research Partners, LLC - Analyst [37]

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Okay. And then you mentioned some of the other aero structure suppliers having come to some sort of agreement on the MAX with Boeing. Is there anything different about what you guys do that would preclude you from having an agreement similar to, say, Spirit AeroSystems, who's just going to continue delivering at 52 a month and seems like all the working capital impact or anything would flow up to Boeing as opposed to staying with Spirit? I mean, is there a reason why or why you couldn't have a similar agreement to that?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [38]

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Well, I think it's a little bit different. I mean if you think of our ship to locations, if you think of our diversity and the materials and the types of products we're shipping to the multiple locations, we don't have an agreement similar to what you're referencing that we've read online with Boeing. Our signal is staying close to Boeing and staying close to their Tier 1s and basically, when they drop orders, fulfilling those orders. So if you think about it, we're providing the raw materials for the Tier 1s or for Boeing to build their components and to ultimately support the final aircraft assembly.

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Operator [39]

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Your next question comes from the line of Ron Epstein with Bank of America Merrill Lynch.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [40]

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It's Kristine Liwag. It seems like the 737MAX delays could delay Boeing's decision on the 7M7 middle of the market aircraft. So if that gets pushed to the right, there's also a chance that a possible A322neo doesn't happen either in the near term. If these things get to the right, which means that possibly investments from you and CapEx from you would also get pushed to the right, how should we think about uses of cash for you in the near and medium term? What will you do with cash that you're generating?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [41]

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So a couple of comments. So relative to how the OEs will respond with respect to their next new platforms, that remains to be seen. And I certainly don't have a crystal ball where I can declare when that's going to happen. What I can tell you is our efforts to develop and qualify and present new materials and material solutions, both to Boeing and Airbus has not slowed down one bit. And it will not. Because regardless of whether the plane is launched 1 year from now or 2 years from now, we need to be there and as you know, these are long-cycle programs, long development cycle programs.

Having said that, our cash priorities have not changed. And that is incremental organic growth that we can find internally. And again, it remains very strong as we've talked about fiber pull, fiber demand, as we look at our thermoplastics development that's going on and having the opportunity for even further secular penetration. We'll invest in those technologies and those assets to support programs when we win them. Second, we'll continue to be opportunistic and look at M&A targets that fit within our portfolio, that expand our technology, that allow us to position in even better and broader range of solutions to our customers in our existing markets. And then last, we'll return to shareholders through dividends and share buybacks. So nothing new there. We'll just monitor it real-time and again, as you know, we had no capacity plans in or forecasted for the NMA. We would do that as we win content and as the program evolves.

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Operator [42]

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Your next question comes from the line of Myles Walton with UBS.

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Louis Harold Raffetto, UBS Investment Bank, Research Division - Equity Research Analyst of Aerospace and Defense [43]

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This is Lou Raffetto on for Myles. So margins, I know you covered them briefly earlier. Just composite materials, really strong; engineered, a little less so, and I know that, that business still has good return metrics. But I'm just curious, were there any onetime costs related to ARC in there? Because I thought ARC would be, I guess, accretive based on the EBITDA margins you guys have disclosed for them.

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [44]

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Yes. I mean, what I would say, Myles (sic) [Lou], is I would say it was a pretty good quarter actually and you have to separate quarter 1 from the other 3 quarters of the year because we have a heavier burden in terms of our OpEx expenses rolling through Q1. So if you look at it sequentially, I can completely get that it looks as if it's down but if you look at it year-over-year, we actually had quite a nice step up in Engineered Products and for Q1, coming in sort of above 12% was actually a pretty good result for that segment. So I can't point to any onetime costs. What I would say is that as the year goes on, ARC will be sort of a strong performer within that segment and without the additional burden of the heavier Q1 OpEx, it should get stronger. And the range I've called out before, sort of 12% to 14%, I think is still valid. And ARC, if anything, will nudge us towards up in that range.

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Louis Harold Raffetto, UBS Investment Bank, Research Division - Equity Research Analyst of Aerospace and Defense [45]

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Okay. Great. And then just one clarification on the onetime action on depreciation. Did that mostly fall into Composite Materials? Or is it spread?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [46]

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It relates to Composite Materials, yes. It was just a good program that sort of reached its end as they do periodically and we accelerated some of the depreciation associated.

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Operator [47]

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Your final question comes from the line of Chris Kapsch with Loop Capital.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [48]

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I wanted to clarify the -- in your formal comments, you -- in the reaffirmation of guidance, you said you're evaluating a number of scenarios and then in the Q&A, I think you said you did factor in a little downside on the 737 programs. So I'm just wondering, the -- so based on the current guidance, are you -- even though you haven't had demand signals that reduced your shipments tied to 737, are you assuming in your guidance that there is some of that offset by other programs?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [49]

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Absolutely.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [50]

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Okay. And then the -- just from an order magnitude -- this was asked, but I don't know if you quantified it. On an order of magnitude, the content is skewed more towards engines and nacelles versus airframe and that sounds like the part of the supply chain that may keep going just to sort of catch up given there had been bottlenecks there it sounds like. Just order magnitude in terms of content per plane. Is that engine and nacelles maybe 70% of your content? Or can you quantify that at all?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [51]

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Yes. I mean, as Nick laid out, Chris, we ship -- we have engines, nacelles they're clearly significant but we also have airframe structures, secondary and tertiary things. We don't sort of specify specifically across the $400,000 shipset. But yes, I mean, we called out before when we went from the legacy 737 to the MAX, that was an increase of $100,000 and most of that $100,000 per shipset increase was engine and nacelle driven as you would expect because it was a reengineering program. So engines and nacelles are clearly a significant portion of that overall shipset.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [52]

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Okay. And if I can just ask one on the development efforts in PEEK and thermoplastic versus thermoset epoxy. This sounds like an intriguing secular story and I'm just curious about how nascent or how far along is the commercialization of these sorts of programs. My understanding is this helps avoid autoclave and therefore, presumably, a lot more efficient for the manufacturer. But is it targeted primarily at commercial airliner market? Or is as an opportunity that's much broader including automotive?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [53]

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Well thermoplastics have been around for many, many years and very big and prevalent in automotive. Our efforts today are focused primarily on aerospace. And obviously, they're starting with smaller, simpler parts where you can avoid tooling and to your point, you can basically improve throughput, lower cost and offer opportunities to displace additional metals. So that's really our focus. We're -- I'm very excited. I visited our site where we have our line running materials. It's looking very good. And like I said, our relationship with Arkema, it couldn't be going any better. We've got multiple development focuses on the thermoplastic front in different material forms. And we look forward to sharing more with you as we continue to penetrate and win more programs.

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Operator [54]

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This concludes today's conference call. You may now disconnect.