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Edited Transcript of HXL earnings conference call or presentation 23-Oct-18 2:00pm GMT

Q3 2018 Hexcel Corp Earnings Call

STAMFORD Oct 24, 2018 (Thomson StreetEvents) -- Edited Transcript of Hexcel Corp earnings conference call or presentation Tuesday, October 23, 2018 at 2:00:00pm 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

* John Patrick McNulty

BMO Capital Markets Equity Research - Analyst

* Krishna Sinha

Vertical Research Partners, LLC - Analyst

* Matthew Carl Akers

Barclays Bank PLC, Research Division - Research Analyst

* Michael Joseph Sison

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

* Myles Alexander Walton

UBS Investment Bank, Research Division - Research Analyst

* Noah Poponak

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Robert Michael Spingarn

Crédit Suisse AG, Research Division - Aerospace and Defense Analyst

* Ronald Jay Epstein

BofA Merrill Lynch, Research Division - Industry Analyst

* Sheila Karin Kahyaoglu

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Standard Webs titled Explaining Hexcel Third Quarter 2018 Earnings Conference Call. (Operator Instructions)

I would now like to introduce your host for today's conference, Patrick Winterlich, Chief Financial Officer. Sir, you may begin.

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

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Good morning, everyone. Welcome to Hexcel Corporation's Third Quarter 2018 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 that 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 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 Kurt Goddard, our Vice President of Investor Relations. The purpose of the call is to review our third quarter 2018 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 today. Our third quarter results demonstrated continued momentum and supports our positive outlook to finish 2018 strongly.

As you all have read in last night's release, our third quarter sales were $540 million, a 10.4% increase over our third quarter 2017 sales in constant currency. We delivered third quarter operating income of almost $97 million, which increased 8.3% from last year's third quarter, resulting in an operating income margin of 17.9%. Our adjusted diluted EPS of $0.80 rose nearly 13% above last year's third quarter. Free cash flow for the first 9 months was $128 million versus $87 million for the same period last year, representing a $41 million improvement.

Now let me share some insight into the key drivers for the quarter, starting with Commercial Aerospace. Sales increased 6.1% in constant currency for the quarter compared to 2017. Narrowbody programs, both in terms of build rates and the higher ship set content on the Neo and the MAX, continue to be key growth drivers. Year-to-date, our Commercial Aerospace sales are 8.4% higher in constant currency, reflecting solid and continued growth for the A350, 787, 777X and the narrowbody programs.

In recent quarters, we have also seen a resurgence in regional and business aircraft. Sales this quarter in Other Commercial Aerospace were up 15%, driven by a number of Bombardier, Embraer and Dassault programs. You'll remember that in 2017, sales in this sector were down 6.5%, so we are seeing a strong recovery in this market space.

Turning to Space & Defense. Sales of $90 million reflect an increase of just under 10% in constant currency for the quarter as compared to the third quarter of 2017. Higher sales in military and commercial rotorcraft more than offset the previously announced lower Airbus A400M production rate. Key ongoing programs for Hexcel include the F-35 Joint Strike Fighter, the V-22 Osprey, the UH-60 Blackhawk, and we are beginning to see the ramp-up for the CH-53K heavy lift helicopter. As a reminder, Hexcel enjoys strong positions in the Space & Defense sector, which continues to be a leading adopter of advanced composites. We benefit from our diverse portfolio of applications that support more than 100 active defense programs.

Finally, to our industrial market, which accounts for 13% of our year-to-date sales. Total industrial sales of $77 million in the third quarter represents an increase of more than 38% in constant currency. As a reminder, last year, we reported that sales were challenging in this market and that we expected to see an improvement in 2018 as legacy wind energy blades transition to higher composite content blades. As you can see from our results this quarter, I'm pleased to report that improvement is taking shape, with wind energy experiencing a period of substantial growth. The fact that the world continues to adopt clean and affordable wind energy is a tailwind for Hexcel, and we're excited to see continued strong demand.

During the third quarter, Hexcel performed in line with expectations by almost every measure, and we are proud of our results, supported by our key initiative of operational excellence. Despite the headwinds of unfavorable exchange rates, higher-than-expected AN and wind resin pricing and new tariffs in the U.S., which negatively impacted margins, our team proved yet again they are the strength within, delivering another disciplined first-class performance.

As we look to finishing out 2018 strongly and on target to hit our guidance, I want to remind you of Hexcel's commitment to driving shareholder value, the first being investing in innovation to win future programs and expand composite penetration. Over the last 3 months, we showcased that commitment by driving innovation and growth. Let me share some examples.

Earlier this month, we celebrated the grand opening of our Roussillon plant in France, which will help us meet the growing demand for advanced aerospace composites. Admittedly, getting Roussillon ready for business has been somewhat of a headwind over recent quarters, yet we expect it to quickly switch over to a tailwind and produce a great return on our investment beginning in early 2019. Remember that Roussillon becomes our first plant to produce both PAN precursor as well as carbon fiber in an optimized supply chain configuration. This co-location of assets is further evidence that from raw materials to flyaway parts, Hexcel is committed to being the most vertically integrated advanced composite company in the world.

In September, our Acousti-Cap sound-reducing honeycomb completed a successful joint NASA-Boeing flight test on a 737MAX test platform. This solution provides approximately 40% noise reduction compared to the legacy platform. Also in September, Northrop Grumman conducted its first ground test of the GEM 63 motor for the Atlas V rocket using our carbon fiber, reinforcements and prepreg.

And in Industrial, the new Lamborghini Aventador SVJ supercar was introduced, and it includes Hexcel composite materials throughout, including the safety-critical monocoque, the rear spoiler and the roof.

As the advanced composites leader, innovation and technology are at the heart of what we do at Hexcel. We continue to invest significantly in R&T and manufacturing innovation to drive the development and adoption of advanced material technologies and continually broaden our technical solutions for our customers.

Our second commitment is exploring M&A opportunities, which includes pursuing with vigilance and discipline adjacent technologies that would complement our existing portfolio. We believe this provides another strategic avenue for us to grow. These investments will be supported by our continued journey from cash investment to cash generation. For the first 9 months of the year, our free cash flow was $128 million compared to $87 million in 2017. We remain committed to achieve greater than $230 million in free cash flow in 2018, which would be a record year for Hexcel.

Investment in innovation to win new programs and expand composite penetration, significant growth in free cash flow and continued stock repurchases and returning cash to shareholders through dividends all demonstrate our commitment to creating value for our shareholders.

In summary, we are proud of yet another strong quarter, thanks to our team's focus to deliver on our commitments. As a result, we are narrowing our guidance ranges for 2018. We now expect full year sales between $2.14 billion to $2.2 billion and adjusted diluted earnings per share of $2.99 to $3.07. We target sales to achieve high single-digit increases in Commercial Aerospace and Space & Defense, and we expect a strong double-digit year-over-year increase in our industrial sector.

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. Let me begin with a review of our markets. As usual, I will discuss year-over-year comparisons in constant currency. As a reminder, currency movements influence our reported results, and some of these impacts may not be intuitive. The majority of our revenues 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 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. As a result, there is a smoothing impact to currency rate fluctuations. The continued strengthening of the dollar as 2018 progresses is favorable for Hexcel, although the impact is moderated by our hedging program. Consistent with last quarter, we continue to expect a $0.04 to $0.05 headwind to full year earnings per share, with about a $0.01 impact falling in the third quarter of 2018.

Sales of $540 million in the third quarter of 2018 were up 10.4% year-over-year, making another solid quarter for growth. Our adjusted diluted EPS for the third quarter was $0.80, an increase of 12.7% compared to the third quarter of 2017.

Now turning to our markets. Commercial Aerospace represented 69% of total third quarter sales. Commercial Aerospace sales of $373 million increased 6.1% compared to the third quarter of 2017. Narrowbody aircraft production rates, combined with the transition to the latest-generation Neo and MAX configurations, was the largest contributor to the year-over-year sales growth. Other Commercial Aerospace continued to strengthen, particularly due to continued demand in business jets related to Bombardier, Embraer and Dassault programs.

Space & Defense represented 17% of sales. For the third quarter, Space & Defense sales totaled $90 million, an increase of 9.7% from the same period in 2017. A number of military and civilian rotorcraft programs contributed to the sales uptake, offsetting the expected declines in the A400M program. Satellites and launches also grew strongly, reflecting greater activity in the space sector.

Industrial comprised just -- comprised 14% of third quarter 2018 sales. Industrial sales totaled $77 million, increasing 38.2% compared to the same period in 2017. Wind energy continues to strengthen with the adoption of new generation of blades by our largest wind energy customer, which is consistent with our prior forecast. We remain confident in the strong outlook for our wind energy sales.

On a consolidated basis, gross margin for the third quarter was 26.5% as compared to 27.6% in the third quarter of 2017. Depreciation expense increased year-over-year due to continued investment in the business to support growth.

As Nick briefly mentioned, the third quarter of 2018 was also impacted by headwinds called out after the second quarter, including the cost of acrylonitrile, which is the base raw material for our carbon fiber and is indirectly impacted by oil prices.

Additional tariffs were imposed during the third quarter that will impact Hexcel, though we are actively pursuing methods to try to minimize the impact over time. Last quarter, I called out a resin headwind for our wind energy business due to the temporary pollution control measures enacted by the Chinese authorities. This issue eased some during the third quarter 2018, and while pricing is still elevated compared to a year ago, the magnitude of the difference is lessening as pricing is moving back down. And we don't expect this headwind to continue into 2019.

Total depreciation expense increased $4.5 million from the third quarter of 2017, reflecting continued capital investment. As we have previously mentioned, we expect our depreciation expense to be higher year-on-year by approximately $20 million.

Our continual focus on disciplined cost control led to approximately a 7% reduction in selling, general and administrative expenses year-over-year, while sales grew during the same period.

Research and technology expenses increased $2.1 million or approximately 19% year-over-year as we continue to invest in innovation and prepare for future aircraft platforms and other composite applications that will be the driving force behind Hexcel's long-term growth objective.

For the third quarter, operating income increased $7.4 million to $96.5 million or 17.9% of sales as compared to $89.1 million or 18.1% of sales for the third quarter in 2017. The year-over-year impact of exchange rates was effectively neutral due to our currency hedging program.

The Composite Materials segment represented 80.1% of total sales and generated an operating income margin of 20.6% for the third quarter of 2018 as compared to 21.7% margin in the prior year period. The Engineered Products segment, which is comprised of our structures and engineered core businesses, represented 19.9% of total sales for the third quarter. Engineered Products generated an operating income margin of 14.4% for the third quarter of 2018 as compared to a 13.1% margin in the third quarter of 2017. The year-to-date margin is now 13.5%. While the operating margin is lower than Composite Materials segment, Engineered Products requires a much lower level of investment, generating returns on invested capital that are as attractive as those as the Composite segment.

The effective tax rate for the third quarter of 2018 was 9.1%. This effective rate was favorably impacted by changes related to: the 2017 Tax Cut & Jobs Act or tax reform; changes in tax accounting methods; the release of a valuation allowance related to one of our foreign jurisdictions; and ongoing business developments that affected our transfer pricing, which will have a favorable impact on our ongoing tax rate. We are now guiding to an underlying effective tax rate of 24% for the fourth quarter of 2018.

Free cash flow totaled $128 million year-to-date compared to $87 million for the comparable prior year period. Working capital was the use of cash during the third quarter, reflecting the growth in revenue in 2018. Strong focus continues in this area, and as we have seen in prior years, we expect working capital to be a source of cash in the fourth quarter of 2018.

Capital expenditures were $43 million for the third quarter on an accrual basis. In comparison, capital expenditures in the third quarter of 2017 were $48 million. Year-to-date 2018 capital expenditures are in line with our 2018 financial guidance.

We repurchased $102 million of common stock during the third quarter, bringing our year-to-date repurchases to $283 million. We have $460 million remaining under our share repurchase program.

We expect the Roussillon, France facility to gain aerospace qualification early in 2019, and once this is completed, production will ramp quickly. Roussillon, which was a headwind in the first half of 2018, is transitioning in the second half and will contribute to margin early in 2019 following aerospace qualifications.

In conclusion, I will address our updated 2018 guidance. Whilst there were a number of headwinds that developed during 2018, we are benefiting from continued market growth, operational strength across our business and a lower tax rate. We are forecasting full year sales to be between $2.14 billion and $2.2 billion. Previous guidance was a range of $2.1 billion to $2.2 billion. We are forecasting full year adjusted diluted earnings per share to be between $2.99 and $3.07. Previous guidance was a range of $2.96 to $3.10. We continue to forecast generating free cash flow in excess of $230 million for the year. We are forecasting accrual-based capital expenditures of $170 million to $190 million, which is unchanged. I would like to remind you that our capital expenditures continue to support investment for growth over the next several years, both to aerospace and industrial applications.

Our capital allocation priorities continue to be investing in organic growth, followed by targeted and disciplined M&A. And we are committed to returning greater than 50% of our net income to shareholders through dividends and stock buybacks.

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. Hexcel delivered a solid third quarter and continues to be on track to meet our full year guidance. At Hexcel, our team consistently demonstrates the ability to deliver on commitments through a strong focus on operational excellence, constantly striving to achieve higher levels of productivity and efficiency while leveraging costs as our sales grow. Our markets are strong, with continued long-term growth expected. Our focus throughout the remainder of 2018 continues to be driving innovation and operational excellence to achieve strong, sustainable financial results. The transition from an investment cycle to a cash-generating cycle is clear. Our disciplined capital deployment priorities remain unchanged, and we are delivering on our commitments to our shareholders. Revenue passenger traffic is robust. Backlogs are strong. And Hexcel has not been affected by any bottlenecks in our customer supply chain, which we expect to continue to be the case.

Sales growth in Commercial Aerospace will continue as existing programs strengthen and as new programs, such as the 777X, begin to ramp up and as new engines and nacelles, where we have substantial composite content, are adopted across next-generation program.

Our composite shipset for engines and nacelles are growing considerably, with new narrowbody engine and nacelle content increasing threefold and wide-body engine and nacelle content going up 50%. Anticipated revenue growth from engines and nacelles over the next few years is in the high single digits.

We also expect solid growth to continue beyond 2018 in Space & Defense programs such as the JSF, the CH-53K and medium lift helicopters. And our industrial market provides a multitude of opportunities ranging from wind to automotive and energy electric vehicles, to energy storage, where advanced composites have a key role to play in solving future light weighting challenges.

It should be clear, growth remains a key strategic focus for Hexcel. As we have said before, advanced composites are a secular growth story, providing the best strength to weight ratio of any structural materials. The advantages of composite are evident: lighter, stronger, greater durability, and there are enormous opportunities in front of us on new, more composite-intensive applications in aerospace and beyond.

We're confident in our position as a global leader in advanced composite technology and expect to continue generating sustained long-term growth and creating shareholder value.

Ashley, we'll now turn it over to you and like to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first 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 [2]

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In terms of Commercial Aerospace, Nick, and you think about 2018, I know you don't give specific guidance yet, but it still sounds like there's a lot of momentum in engines, nacelles and such. So when you think about the growth rate heading into '19 relative to, let's say, '18, should it mirror '18? Should it get better? Should it be about the same? A little bit less?

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

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Well, Mike, you're right in your first assumption that it's a little early for us to give specific guidance. But I will say, if you look at the fundamentals and if you look at revenue passenger growth, if you look at the backlog, if you look at even order intake during Farnborough Show this year, you look at the fact that the 787 is ramping to 14 in 2019 and you look at the fact that 2019, we should see a full year of rate 10 per month, all of which translate into strong growth for us. And then, certainly, the narrowbodies, which really were the biggest driver in Q3, continuing to ramp up both the shipset content benefit as well as the rates, climbing upwards to 63 and 57 in 2019.

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Michael Joseph Sison, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [4]

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Great. And then for wind, you talked about moving more composites on the blades from the legacy wind blades. This has been a banner year for that. Does that have a lot of legs heading into '19 and '20? Is it sort of all done? Or do we still have a lot of opportunity there in terms of adding more composites?

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

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Yes. So, again, just as a reminder, remember, 2017 was really soft. And we guided back at the end of '17 that '18 would be -- we expected it to be at or better than 2016 levels, which it has been. Having said that, our key customers are still ramping up, and we expect the growth to continue well into 2019 and beyond.

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Operator [6]

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And our next question comes from the line of Krishna Sinha with Vertical Research Partners.

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Krishna Sinha, Vertical Research Partners, LLC - Analyst [7]

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Just to talk about the margins real quick, you called out 3 separate components there that are headwinds. You called them out last quarter. But it sounds like tariffs, last quarter you said, would be a $2 million to $3 million annual impact. How much do you think it's going to be an impact now that they've increased? And in worst case scenario going forward, how much can we expect for that to take out of margins? And then same questions for the acrylonitrile price cost issues you're having. And then resin sounds like it's going away, but can you just kind of size that for us as well?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [8]

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Yes. So in relation to the tariffs, we called out a $2 million to $3 million impact sort of following second quarter earnings. What we've seen in the third quarter would push us to probably say $4 million to $5 million. What I would say -- and that's already $4 million to $5 million on an annual basis. What I would say is we're working hard to get exemptions on part of that, hopefully, just over half, 50%, 60% of that, that we can mitigate and we can avoid as a unique sort of supply chain that we may be able to offset those tariffs. But obviously, we are watching the tariff space closely, and we'll do what we can to mitigate it. But all else aside, if we can't do anything, it is $4 million to $5 million, which after tax and dividing it, it's probably $0.04 to $0.05 of EPS. In relation to AN and the wind energy resins, we obviously haven't and we don't intend to put exact dollar amounts around those. The wind resin, the price is easing a little bit. And through our contracts, we have an opportunity to sort of rebate as we go into 2019 to overcome that. So as I've said, we don't see that as a headwind in 2019. The acrylonitrile is the base for our carbon fiber. That has gone up as a result indirectly of oil prices. We have some oil clauses in a number of our commercial contracts that allow us to move our pricing periodically, so some of that impact will be mitigated. What I would say is, just to put a perspective on this, AN is sort of right at the front end of our vertical supply chain. It's not our biggest raw material. So for example, epoxy resins that go into our films, we have long-term contracts on, and so we are protected from the price of oil, where that would be a bigger impact for us. And our commercial contract is running through 2030. We have supply contracts also through 2030 that protect us there.

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Krishna Sinha, Vertical Research Partners, LLC - Analyst [9]

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Okay. Just one follow-up. Just pursuing the gap here because you got some benefit from the tax rate in the quarter, call it, $12 million or $13 million. And then you've -- it sounds like the tax rate will level off in the fourth quarter back to sort of 24%, 25%. But that kind of -- you reiterated the EPS midpoint of your guidance. And so I'm just trying to figure out what's the gap there. Is that just all acrylonitrile, resin and tariffs? Can you just kind of size that for us?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [10]

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Well, I mean, you're obviously putting the right pieces together. I mean -- so we have the headwinds. We've got the acrylonitrile. We've got the FX, which we've consistently said against our guidance is about $0.05. We've got the tariffs, which we've just talked about. We've got the wind resins, which continue through this quarter. So those have all been headwinds. In the first part of the year, we had Roussillon, the new plant in France, which is now transitioning and will become a tailwind as we go into 2019. So those are headwinds which these guys operationally, our teams, have worked very hard to overcome as much as possible. And then with the help of tax, we are getting ourselves to deliver our guided EPS. The tax rate, I would say, is 24% now, our underlying effective tax rate. And that's what you'll see in the fourth quarter. So the average for the year is clearly -- I think we're, what, 21.3% through the first 3 quarters, 24% in the last quarter. I guess I'm saying about 22% or so for the year. And 24%, as I sit here today, is my best view forward on tax. So it's a combination of working hard to overcome the headwinds, a lot of which are going to sort of disappear as we go -- or certainly lessen as we go into 2019. And with a little bit help with tax, we're going to deliver our initial forecasted numbers.

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Krishna Sinha, Vertical Research Partners, LLC - Analyst [11]

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Okay. And just one more follow-up then. Can you bridge to the -- you didn't change your free cash flow guidance. And so does that kind of imply that CapEx will come in towards the lower end of your range in order to kind of help you, you reiterated $170 million to $190 million of CapEx. Do we see a little bit of a CapEx pullback in the fourth quarter in order to kind of help you hit that $230 million or more of free cash flow?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [12]

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I would expect us to come in, in that range, and we've obviously deliberate -- the midpoint is what it is deliberately, let me say that.

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Operator [13]

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Our next question comes from the line of Sheila Kahyaoglu with Jefferies.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [14]

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I'm trying to avoid saying the word acrylonitrile, but I guess it's going to happen. How do we think about that raw material? Are there any raw material -- other price increases that you're seeing outside of that one and resin? And the timing of when the contracts catch up, Patrick, you seemed to suggest it's a step-up in a long-term commercial contract and how we could think about when they match up.

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [15]

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Yes. So most of our key raw materials, certainly, our major epoxy multifunctional resins, as I was saying, are covered by long-term contracts. So we do a very good job to mitigate that impact. Acrylonitrile floats, it's related to a propylene formula we buy on, which is related to the price of oil ultimately. And we have had some headwinds for that. Now we're not going to quantify that exactly, but it has been a headwind. It's hard to -- we have different commercial contracts, as you can imagine, and they're structured differently. But we have a number of them with clauses, which will allow us to recover some of the oil price movements as a proxy for the AN. And obviously, over time, that will lessen the impact. So again, we would be more positive as we go into 2019, but the elevated price of oil may well continue. I mean, that's anyone's guess. But we believe we will continue to do a better and better job in overcoming that impact.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [16]

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Okay. And then just on Roussillon as it comes online and you receive aerospace qualification, what's the cadence of capacity that's coming online? And how do we think about just the capacity utilization in that facility next year?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [17]

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The line -- so as we've said, the line should be qualified towards the end of this year, and we would expect it to ramp up with the aerospace qualification starting in 2019. It will get to capacity very quickly. Once it's qualified, the facility is running, it will fill. We need that capacity. As Nick said, we will have rate 10 on the A350 next year, and in part, it will support that and it will support other Safran and aerospace programs. So that capacity will fill quickly starting in 2019.

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Operator [18]

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And our next question comes from the line of Robert Spingarn with Crédit Suisse.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [19]

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Nick, thanks for the color on the growth that you had a little while ago. I wanted to dig in to that a little bit further. And I guess a lot of people are focused on this. But based on your current book of business, most of your commercial aero programs achieved mature rate next year. So is it fair to conclude that, that part of the business plateaus on a revenue basis in H2 '19, perhaps with the exception of what you talked about on the engines and nacelles and the 777X?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [20]

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Yes. So, Rob, there's still going to be continued growth on the narrowbodies. They're going to continue to ramp up. The 777X will be starting and -- at the end of the century and going into 2020. So given the other engine and nacelle programs, we still see good growth going forward. We haven't changed our long-term guidance that we provided. And we continue to work on new opportunities and applications, including the -- finalizing our shipset content on the 777X, which we're getting very close to being able to do, and I hope to do that by the end of the year. The other thing is really getting a full year of full rate on the 787 at 14 and the A350 at 10. That's going to provide continued growth as well.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [21]

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Well, understanding that won't hit till 2020, but I wanted to -- your comment on narrowbodies continuing to grow, are you talking about the possibility that Boeing and Airbus go above the current targets?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [22]

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Going above the targets that they've said. The 63 and 57 are the latest that they've communicated. And we're not going to go beyond that, but we're certainly doing trades to ramp up above that.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [23]

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Okay. And then have you been able to quantify -- you said 777X you'd give us more information soon, but can we get some sense of what the content is relative to the 777?

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

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It's going to be higher, and in my terms, significantly higher. So we're happy with that. Again, we've got a couple of other packages that we're working on. And rather than get ahead of those, I want those to get awarded, and then we'll communicate.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [25]

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Okay. And then just on the fourth quarter. The way the guidance reads, Patrick, is you could be down $30 million or up $30 million in sales. Is that all simply timing? And if it is, what is it the timing on? And then my last question is on the wind growth of 50% this year. You talked about the easier comp, but how do we think about that 50% in terms of volume versus pricing and content?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [26]

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Okay. A couple of questions there. So I mean, we always get some movement in our sales and our sales mix, and then you've obviously got a little bit of FX, which can move our number about. And we obviously tightened the range. Perhaps we didn't tighten it enough for you, but we...

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [27]

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Both up and down, which is -- sequentially which is the...

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [28]

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Yes. So we see $2.17 billion to, obviously, as the midpoint of what we said. You can obviously do the math where we're kind of guiding to for that. It's just above where we guided to at the beginning of the year. And you can get some pull-ins, pull-outs. We -- I mean, we have a complex supply chain that we're putting material into, and we think that's a reasonable range. We're obviously aiming for midpoint. In terms of wind energy, in terms of wind energy, the growth is good at good margins. I mean, obviously, we've talked about the wind energy resin headwind, which has been a headwind this year, so our margins are a little bit depressed because of that. But again, going into 2019, we can see continued growth in wind energy, and without those headwinds, it should be a strong market space for us.

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Operator [29]

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And our next 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 [30]

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I have 2 questions. First, I was wondering if you could comment on how downstream yields have changed, if at all, among your many customers on the A350 or any other programs. Or should we -- are the revenue per shipset disclosures that you've given in the past still tracking to what you're seeing?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [31]

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Yes. I would say, they are close. I mean, we look at this -- I think as where we explained before, where we continually roll. As we roll our strategic plan, we dig into the supply chains, which is can be complex for us because we ship to multiple OEMs, multiple subcontractors of the OEMs and many delivery locations themselves. And so we are continually trying to assess those shipsets on the planes, and we stand by what we've put out today. So we're certainly in those ballparks, close just below, just above. We will revise them periodically. In terms of the efficiency in yields of our customers, as rates go up, certainly, as you go through a growth curve or a learning curve for the new platforms, we would expect our customers to improve. And what I would remind you is the shipsets that we put out attempt to be at the final full build rate, rate. Now the early planes, the first 1, 5, 10 planes, take far more material. The buy-supply ratio is much higher, but we build that really into what we put out. So at the moment, the A350 is getting close to 10. We don't expect to see a lot of movement there. The 787 rate 14 -- sort of rate 12, 14, has been at that elevated level for some time. We don't expect to see a lot of movement. So any new program, we do go through a curve. But as I say, the shipset value we put out, we are trying to estimate that final position from the beginning. So we try to avoid adjusting the shipsets as much as possible.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [32]

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I appreciate it. And my follow-up question was, given the CapEx number, it's down obviously year-over-year in 2018, what does that portend for D&A next year? Does -- how much does D&A rise?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [33]

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So we saw -- or we will see about a $20 million step-up this year. We will see an increase next year. It won't be as large as that. I haven't sized it exactly yet. In fact, we are still rolling that up. But it will be less than $20 million but more than $10 million, I would safely say. It will be in that range.

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Operator [34]

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And our next question comes from the line of Ron Epstein with Bank of America.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [35]

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Just a couple of quick ones. As you transition more into this cash generative mode and you think about deploying that cash, particularly as we go into '19 and '20, that sort of thing, how are you thinking about that?

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

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Well, we've been pretty consistent. First, we're looking at internal organic opportunities to position our materials for the next-generation aircraft engines and nacelles or wind turbine blades, so organically investing in capital and capacity to meet that demand. Second, looking at technology plays in and around our core space, around advanced materials, material science, composites, that would help us offer a broader and even better solution to our customers for those next-generation programs and/or to gain incremental shipset content in aerospace or industrial markets. And then lastly, it's just returning value to shareholders through dividends and stock buyback, while maintaining a debt leverage that we're comfortable with. And we've shared we kind of like the 1.5 to 2 range and all the way up to 2.5, if required.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [37]

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Okay. And then I think in your commentary, if I understood it, that there are still maybe some packages on 777X that you could win. If you were to, would that require additional investment? Or can you do that in your current capital?

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

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No. Those packages, we have assets available today.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [39]

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Okay, okay. And then finally, when you think about the potential for the middle of the market airplane, do you see that as requiring -- I mean, I guess this is really premature, but I'll ask anyway. Do you see that as requiring big CapEx from you, guys? Or does it really just kind of depend on what you win and how it plays out?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [40]

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Well, that's exactly right, Ron. If we're successful in what we're going after, I would be delighted to come and share with you that we're going to have an incremental CapEx spend to meet that demand, which would be a very profitable growth, a great return on invested capital. So again, we're working on engines and nacelles. We're working on secondary structures. We're working on primary structures. And clearly, it's too early to declare, but time will tell after the program gets launched and after we continue to demonstrate our capability with respect to technology with our various customers.

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Operator [41]

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And our 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 [42]

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When you think about the M&A opportunities out there on the technology platforms you're looking for, I guess, are you seeing -- from your perspective, is -- are the targets or the number of targets out there increasing, given kind of what's been going on in the markets, and also with rates going up? Because I guess I would understand that a lot of these are smaller private companies that may have to work on funding through debt. So I guess, how should we be thinking about that, whether it's a target-rich environment for you or not right now?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [43]

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Yes, John. Well, you know our space fairly well, and I'm not going to say there's hundreds of targets out there. But the fact that scale is becoming a factor, there are some private opportunities that are presenting themselves. There are some technologies that fit very well that we continue to look at. Obviously, some of them are actionable, some of them are not and some of them may become actionable. So the fact that there are some dynamics within the M&A, that too can create opportunities for possibly noncore components of bigger breakups or bigger acquisitions that may afford an opportunity for us to add that into our advanced science portfolio.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [44]

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Okay, great. Appreciate the color. And then I guess, one last question on the raw material front. It sounds like you can make up at least some of the issues around acrylonitrile with crude-related escalation price clauses or what have you with some of your contracts. Can you work around the rest of the impact? Because it doesn't sound like you're going to make it all up there. But can you either reformulate, improve efficiency? I assume the reformulation part is a little bit difficult. So I guess, how do you -- if oil stays here and acrylo stays here, how do you actually catch up entirely on it? Or can you?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [45]

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Yes. So for future programs that are not qualified, we have opportunities to do formulation. And as you can imagine, we are working that aggressively to help mitigate future costs and actually to drive more productivity into the business. We're also working hedging strategy on AN, which we've initiated this year, which will help provide some stability. And then on the resin systems, again, as Patrick mentioned, we do have contract protection, long-term contracts, that mitigate a good portion of that impact.

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Operator [46]

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And our next question comes from the line of Noah Poponak with Goldman Sachs.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [47]

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Nick, in your prepared remarks, you specified anticipating revenue growth from engines and nacelles over the next few years in the high single digits. And I guess I was a little surprised by that specification because I would expect that to be one of the faster-growing pieces of your aerospace business and you have an outstanding multiyear upper-single-digit target for your entire aerospace business. So I mean, should I read that as you're expecting the aggregate to be slower than engines and nacelles? Or is the aerospace ex engine and nacelle, does that have as much growth opportunity and you were just kind of highlighting that today?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [48]

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Well, Noah, we hadn't provided a ton of clarity around how strongly our position is on engines and nacelles with fan blades, cases and then nacelle materials and the fact that there are always derivative programs. Even after planes are launched, there are many more derivatives than there are new aircraft launches. So if you look at our strategic plan, which we just rolled up for the board, engines and nacelles and the opportunities we have in the near, mid and long term are certainly very strong. Now I don't want to get into updating our longer-term guidance. It, too, is strong. And I'm not going to differentiate which is stronger or what the overriding commercial aerospace growth rate is. But engines and nacelles is a strategic target for us. We've invested in that. Our investment in Morocco was another area where we are parlaying, and the site is doing quite well. So it was just to give you a little more color around the areas we're focused on to continue to drive growth beyond 2020 and until the next new programs are launched.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [49]

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I see. Okay. And then, Patrick, do you expect your segment operating margin to be up year-over-year in 2019?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [50]

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Well, if we take away a number of the headwinds and we believe we've got strong continuing growth opportunities, then the answer to that is yes. I mean, what I would -- certainly, Composite Materials. Engineered Products tends to bounce around a little bit, and we're sort of in that 12% to 14% range. Year-to-date, I think we're 13.5%. But certainly, for Composites, yes, and we would look to maintain what I would say is a pretty good Engineered Products' performance. So overall, definitely yes.

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Operator [51]

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And our next question comes from the line of Christopher Kapsch with Loop Capital Markets.

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

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I had a follow-up question on the Roussillon facility. And just generally, are there any -- has there been any surprises thus far in your efforts to qualify that integrated production facility? And then assuming the time line is -- remains intact, is there any way to quantify the anticipated margin benefit for '19? I'm just wondering if we should be thinking about -- as that is qualified and ramps, are we talking about just a better absorption of this fixed cost? Or is there any knock-on benefits maybe in the form of like better product mix or maybe even optimizing your global manufacturing footprint?

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

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So I'll give you a little overview. We just had the grand opening at Roussillon. It was an incredible event, with quite a few customers and French dignitaries and global suppliers and partners attending. The plant looks absolutely fantastic. It is state of the art. It was fully running as we toured the site. And I'm very excited with the progress we've made. So have there been any surprises? It's a big project, $250 million investment. It was a little later than we expected. There were a little more headwinds than we expected. Having said that, it is the first co-located site which will translate into an optimized supply chain, which will afford us opportunity to drive even more productivity. Our proximity to our customers and shipping materials directly to Safran and Airbus and others versus bringing materials from the States or, in some cases, going from Europe to the States back to Europe, is clearly an opportunity to improve our supply chain. So at the end of the day, we're excited. The site is running very well. We're going through the qualification process, which is just a matter of doing various lots, running them through the test cycles, working with our customers to get the approvals on multiple levels of fiber technology and then turning the equipment on and letting it run. With respect to the tailwind, we're really not going to get in and calibrate you, but I can just tell you, we're totally excited to put that behind us. The team is motivated, and we think 2019 is going to be a very, very strong year on the carbon fiber front. And, Patrick, can you add?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [54]

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The only thing I would say, Christopher, is, as we've said before, our carbon fiber assets are major investments and carbon fiber drives good strong margins, and we would expect to see those typical good strong margins come out of that facility as they do our other ones. So it will be a normal carbon fiber margin at benefit to the overall mix of the company.

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Christopher John Kapsch, Loop Capital Markets LLC, Research Division - MD [55]

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Okay. That's helpful and good stuff. And just on the -- just as a follow-up, the step-up in D&A that you experienced this year and that you called out for '19, how much of that is tied to the Roussillon integrated facility?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [56]

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Well, without wishing to be too precise, I mean, it was a $250 million investment we called out. We depreciate those sorts of assets over about 20 years. So you can see certainly a chunk of that plant is going to come into next year, yes.

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Operator [57]

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

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Myles Alexander Walton, UBS Investment Bank, Research Division - Research Analyst [58]

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I was just curious, were you at rate 10 on A350 in the third quarter...

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [59]

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Myles, you need to speak up, we can't hear you.

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Myles Alexander Walton, UBS Investment Bank, Research Division - Research Analyst [60]

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Sure. So were you at rate 10 on the 350 in the third quarter? Or is that more of a fourth quarter impact? Just looking at the Composite Materials, Commercial Aerospace sales declined sequentially.

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [61]

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Well, it's hard -- well, I mean -- yes, I mean -- okay, that's a third quarter European closedown. Third quarters can be a little bit funny. In terms of the A350 specifically, we know Airbus are aiming to get to rate 10 by the end of the year. We're supplying all that material. We've obviously seen the ramp-up in the year. We delivered, as we've said in the past, to over 40 different addresses. It's very difficult for us to say exactly we're at rate 8 or 9 or 10 and even higher potentially if there's a mix issue somewhere or a catch-up, I should say. So we're in that range. We know we're giving them the material they need to get to rate 10 by the end of the year. We're not seeing anything massive between Q3 and Q4, if that's your question, in terms of the A350, but we know it's going to keep going up. And obviously, if it's rate 10 all of '19, then they've got to fill their supply chain ready for that. So...

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Operator [62]

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And our last question comes from the line of David Strauss with Barclays.

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Matthew Carl Akers, Barclays Bank PLC, Research Division - Research Analyst [63]

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It's actually Matt on for David. Just real quick on buybacks. I guess you guys have been buying back a fair amount of stock. Should we expect that pace of buyback to kind of continue? And how willing are you guys to sort of lever up to do more buybacks?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [64]

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Yes. I mean, our capital deployment priorities remain the same, sort of organic growth, M&A, we're paying dividends, and we'll do stock buyback. As I think Nick said earlier and I reiterate, we want to maintain our disciplined leverage position between 1.5 and 2. We're at the sort of top end of that range. We're not going to give specifics out on as and when we're going to buy back stock. We're going to look at it from multiple perspectives. We certainly believe in the value of the stock. We're going to potentially be opportunistic at times, but we believe in the long run growth in Hexcel, and so we will continue to do it, I would think, as part of our return to shareholders for the foreseeable future.

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Matthew Carl Akers, Barclays Bank PLC, Research Division - Research Analyst [65]

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Okay. And then I guess just to confirm, the 24% tax rate for Q4, is that the right level to think about for 2019?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [66]

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It's the best thing I can say now. We will reaffirm what that will be. We will provide guidance with our earnings in January for 2019, and at that point, we will firm up what the tax rate for 2019 is. But 24% is the best number I could give today, yes.

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Operator [67]

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And I'm not showing any further questions at this time. I would now like to turn the call back over to management for any closing remarks.

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [68]

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No closing remarks. Thanks, everyone, for participating today.

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Operator [69]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.