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Edited Transcript of HXL earnings conference call or presentation 24-Jan-19 3:00pm GMT

Q4 2018 Hexcel Corp Earnings Call

STAMFORD Jan 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Hexcel Corp earnings conference call or presentation Thursday, January 24, 2019 at 3:00:00pm 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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* David Egon Strauss

Barclays Bank PLC, Research Division - Research Analyst

* Gautam J. Khanna

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

* 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

* 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

* Paretosh Misra

Joh. Berenberg, Gossler & Co. KG, Research Division - 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 Fourth Quarter 2018 Hexcel Corporation Earnings Conference Call. (Operator Instructions) I would now like to introduce your host for today's conference, Patrick Winterlich, Chief Financial Officer. Mr. Winterlich, you may begin.

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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 Fourth 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, 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 fourth quarter and full year 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. Today, we're sharing both fourth quarter and full year 2018 results with you, and both set records for Hexcel. We're reporting a solid quarter and full year, and we're guiding to a strong year in 2019.

Let me begin with the fourth quarter. Sales, earnings per share and free cash flow were all records for Hexcel in Q4. We saw an improvement in our underlying operational performance, with the strongest margins for the year. Our fourth quarter performance is a positive indicator that we are well positioned to deliver strong results in 2019.

Now let's turn to some specifics in our full year results, and I'll conclude with our outlook for the market ahead and our guidance for 2019. Full year 2018 sales were almost $2.2 billion, up more than 10% year-over-year. And adjusted diluted EPS was $3.05, an increase of 14% from last year.

In addition, 2018 was another record year for free cash flow generation, which came in at $237 million. These are solid results given a number of headwinds we encountered during the year.

Let me pause here and take a moment to thank our entire Hexcel team. I'm very proud of our global team's commitment and execution throughout the year. They did an extraordinary job in every area and especially in staying disciplined when it came to controlling costs, working efficiently, staying focused on innovation and delivering value.

Our objective is now to continue our focus on sustained operational excellence by driving productivity and process improvements that will lead to enhanced margin quality in 2019 and beyond.

Commercial Aerospace sales in 2018 of $1.5 billion were 8% higher than 2017. We saw continued growth for the Airbus A350 as it increased to rate 10 by the end of the year plus a full year of the Boeing 787 at rate 12. The transition to the Airbus A320neo and the Boeing 737MAX accelerated strongly in 2018, and Hexcel benefited from both the increased shipset values of the neo and MAX compared to the legacy models as well as increased build rates for these narrowbody programs.

We also saw a large step-up in sales volume for Other Commercial Aerospace, which includes business and regional jets. Bombardier, Dassault and Embraer business jets all provided a strong increase in year-over-year revenues.

Space & Defense sales for 2018 were $370 million, an increase of almost 7% over 2017. Our original guidance for 2018 you'll remember was for Space & Defense sales to be stable year-over-year. As the year progressed, we were pleased to see greater-than-expected growth across a large number of programs led by the F-35 Joint Strike Fighter, which more than offset the expected reduction in the A400M build rate.

Military rotorcraft was strong again in 2018, including notably the Blackhawk program. And we also saw a much stronger year for civil rotorcraft, with robust double-digit growth over 2017 levels.

Finally, turning to Industrial, where sales were $294 million in 2018, almost 30% above 2017. This time last year, I said that we were optimistic for a recovery of wind demand in 2018, and our numbers yesterday proved that our technology innovations and efforts to reposition our materials for new wind turbine blades has been successful. Wind sales increased 67% year-over-year as our material was used for blades on a number of new turbines at our key wind customer, Vestas.

Before I get into the 2019 guidance, I'd like to mention a couple of milestones that happened toward the end of 2018. First was the grand opening of our Roussillon plant in France. Roussillon is the largest capital project in our history and our first PAN production facility in Europe. The site is now fully operational and producing qualified PAN precursor and aerospace-grade carbon fiber for Airbus, Safran and other customers.

Second, we announced our intent to acquire ARC Technologies and then we closed on the transaction earlier this month. ARC is a leader in materials science with a technology portfolio complementary to Hexcel and exceptional customer relationships, particularly in Space & Defense. This acquisition combines 2 great research and technology teams to further develop next-generation products for both Space & Defense and commercial applications.

Now that the deal has closed, we're focusing and focused on growing the business and partnering with our customers to provide advanced materials solutions for next-generation programs and applications. All in all, fourth quarter was a strong end to the year, and we have great momentum as we head into 2019.

Now with that end, let me share some insight into the 2019 guidance provided yesterday. Starting with Commercial Aerospace, with strong end markets and backlogs, coupled with robust global passenger and cargo air traffic, we have a positive outlook for Commercial Aerospace. We anticipate high single-digit growth in 2019 sales driven by widebody production rate increases for the composite-rich A350 and Boeing 787 programs with 2019 being the first full year at rate 10 for the A350, and a large portion of 2019 will see the 787 at rate 14.

Second, the Airbus A320 and Boeing 737 build rates continue to grow. Combined with the expected completion of the transition to the neo and MAX upgrades, we expect to see another year of strong growth for these narrowbody programs as well as production rate increases beyond 2019, which is an outlook supported by very strong backlogs, continued strong order intake and general market observation.

Next, the new Boeing 777X is expected to contribute to our 2019 growth as it approaches entry into service in 2020, although this platform is still at the beginning of its growth story. I'm also pleased to report that the Hexcel team has increased our content on the 777X by 50% compared to the legacy version, which brings an expected shipset value of about $1.5 million to Hexcel.

As we look broadly at Commercial Aerospace, we expect ongoing composites adoption across all next-generation platforms, especially in engines and nacelles where we have substantial content and opportunities for further secular penetration. As a reminder, our composite shipset for engines and nacelles is growing considerably with new narrowbody engine and nacelle content, increasing threefold and widebody content increasing 50% for new and re-engined platforms.

Space & Defense continues to be a leading adopter of advanced composites, and Hexcel benefits from our diverse portfolio of applications that support more than 100 active defense programs, and we are actively pursuing new programs and applications. We expect double-digit sales growth in Space & Defense in 2019 driven by strong growth in the F-35 program as it continues to ramp into the next decade; continued strength in military rotorcraft; the ramp-up of the CH-53K heavy-lift helicopter, which is expected to continue in 2019, and we anticipate this aircraft becoming a major program for Hexcel in the years ahead; and the addition of ARC Technologies acquisition, which increases our growth rate in Space & Defense from mid-single digits, excluding ARC, to low double digits with ARC included. ARC Technologies is expected to add just more than $50 million to our revenue in 2019.

Finally, we anticipate double-digit sales growth in the Industrial market for 2019, supported by another year of strong double-digit growth for wind energy. Industrial represents 13% of total sales, and we are pleased with its growth and are continuing to pursue new and expanded opportunities, not only in wind energy, but also on automotive and other Industrial subsectors. Our Industrial market provides a multitude of opportunities where advanced composites play a key role in solving lightweighting challenges.

Now as we turn toward 2019, we have every reason to believe that the discipline we had in 2018 will continue to serve us well. We're proud of our strong performance in 2018 while overcoming a number of unanticipated headwinds. We remain optimistic for robust growth and continued secular penetration as I've outlined. And as a result, the guidance we are issuing for 2019 reflects another strong and record year for Hexcel.

As you saw in the earnings release yesterday, sales are forecast to be between $2.375 billion and $2.475 billion. Adjusted diluted earnings per share is expected to be between $2 -- or excuse me, $3.38 and $3.52. We expect free cash flow of greater than $250 million. And finally, we anticipate capital investments in 2019 to remain in the $170 million to $190 million range for expanded capacities to support continued growth.

Many of you will be invited to join us in Q2 for our Investor Day, and that's when we expect to provide longer-term guidance, outlining our growth and expectations as well as an overview of our technology priorities. This year is going to be an opportunity for you to visit one of our manufacturing locations for the day and to let you hear directly from our business presidents and other Hexcel leaders.

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. Fourth quarter 2018 sales totaled $561 million, an increase of 10.2% year-over-year. Full year 2018 sales were $2,189,000,000, a 10.3% increase over 2017.

Our adjusted diluted EPS for the fourth quarter was $0.82, an increase of 17.1% compared to the fourth quarter of 2017. Full year adjusted EPS was $3.05 compared to $2.68 in 2017. Free cash flow for the fourth quarter was $109 million, resulting in full year 2018 free cash flow of $237 million compared to $151 million in 2017, a 57% improvement year-over-year.

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 cost 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 to currency rate fluctuations. The dollar weakened in the first half of 2018, which was a negative for us versus our 2018 guidance. As a result, changes in exchange rates resulted in a $0.05 headwind to our full year earnings per share compared to our original guidance, with about $0.02 falling in the fourth quarter of 2018.

Now turning to our fourth quarter market performance. Commercial Aerospace represented 69% of total fourth quarter sales. Commercial Aerospace sales of $385 million increased 7.1% compared to the fourth quarter of 2017. Space & Defense represented 17% of our sales. For the fourth quarter, Space & Defense sales totaled $98 million, an increase of 1.9% from the same period in 2017. Whilst activity was broad-based in the fourth quarter of 2018, you will recall that the fourth quarter of 2017 was particularly strong in a number of programs, which influences the year-over-year comparison.

Also as a reminder, we closed on the ARC Technologies acquisition in early January 2019. So ARC is not represented in our 2018 financial results. Going forward, ARC Technologies sales will be included in our Space & Defense market and reported in the Engineered Products segment.

Industrial comprised 14% of fourth quarter 2018 sales. Industrial sales totaled $78 million, increasing 46.7% compared to the prior year period. Fourth quarter wind energy sales were an impressive 123% higher than the same period in 2017.

On a consolidated basis, gross margin for the fourth quarter was 26.8% compared to 27.8% in the fourth quarter of 2017. Total depreciation expense increased $4.1 million from the fourth quarter of 2017, reflecting continued capital investments.

We previously called out several headwinds that collectively impacted 2018, and I'd like to provide more color on these, reflecting our confidence that they are substantially behind us as we move into 2019. First is that our Roussillon start-up costs are now behind us as the plant is qualified, running 24/7 and delivering aerospace-qualified PAN and carbon fiber.

Next, the price of acrylonitrile, which is the base raw material for our carbon fiber, reduced during the fourth quarter as it is indirectly impacted by oil prices. We implemented an AN hedging program during the last quarter of 2018 to smooth the impact of future potential pricing fluctuations and combined with lower pricing at present, we do not foresee acrylonitrile pricing to negatively impact us in 2019.

Third, wind energy resin pricing showed improvement in the fourth quarter of 2018. Our pricing is now rebased as we go into 2019. And therefore, this headwind is behind us.

Fourth is the tariff that were introduced in 2018 and are now forecast to be a 2019 annual impact of approximately $4 million to $5 million. We are actively pursuing exemption options to try to minimize this impact. And we'll provide further updates as the year progresses if tariff levels change.

And finally is foreign exchange, which I already addressed for 2018, and rebased for our 2019 guidance. As we enter 2019, we are greater than 75% hedged for both the euro and GBP currencies, therefore, minimizing our risk exposure.

For the fourth quarter, selling, general and administrative expenses decreased 11% year-over-year while sales grew during the same period as we continue to focus on improved efficiency and managing costs tightly. Research and technology expenses increased $2.3 million or approximately 18% year-over-year as we continue to invest in innovation, so that we are prepared to meet the future needs of our customers and maintain our market leadership position.

For the fourth quarter, adjusted operating income increased 11% to $103.5 million or 18.4% of sales as compared to $93.2 million or 18.2% of sales for the fourth quarter in 2017. For the full year, adjusted operating income was $378.9 million or 17.3% compared to $350.6 million or 17.8% for the prior year. This adjusted operating income figure excludes the onetime restructuring charge incurred during the fourth quarter of 2018.

The year-over-year impact of exchange rates was effectively neutral due to our currency hedging program.

The Composite Materials segment represented 79.7% of total sales and generated an operating income margin of 20.9% for the fourth quarter of 2018 as compared to a 22.3% margin in the prior year period.

The Engineered Products segment, which is comprised of our structures and engineered core businesses, represented 20.3% of total sales and generated an adjusted operating income margin of 14.9% for the fourth quarter of 2018, excluding the restructuring charge as compared to an 11.7% margin in the fourth quarter of 2017.

Full year 2018 adjusted operating margins in Engineered Products was 13.9% versus 12.9% in 2017. 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 is as attractive as those as of the composite segment.

The effective tax rate for the fourth quarter of 2018 was 24.2%. For the year, the final effective tax rate was 22%.

Free cash flow totaled $237 million in 2018, representing record cash generation. 2018 free cash flow generation increased $86 million from $151 million of free cash flow generated in 2017. Working capital grew $31 million during 2018, supporting higher sales.

Capital expenditures were $179 million in 2018 on an accrual basis. In comparison, 2017 capital expenditures totaled $284 million.

We repurchased $75 million of common stock during the fourth quarter, bringing our year-to-date repurchases to $358 million. We have $385 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 are committed to returning greater than 50% of our net income to shareholders through dividends and stock buybacks. In 2018, we returned 150% of adjusted net income to shareholders.

Finally, I would like to provide a little bit more background to our 2019 guidance provided by Nick. as a reminder, we are forecasting sales in the range of $2.375 billion to $2.475 billion, adjusted diluted EPS in the range of $3.38 to $3.52, and free cash flow is forecast to exceed $250 million. Capital expenditures are forecast in the range of $170 million to $190 million.

Additionally, we expect depreciation to increase $20 million in 2019 compared to 2018, which includes $4 million related to the ARC Technologies acquisition. Consistent with prior years, selling, general and administrative expenses are forecast to be higher in the first quarter of 2019 compared to the following quarters, reflecting the timing of recording stock-based compensation expense. This will lead to a lower operating income margin in the first quarter compared to expectations in the following quarters of 2019.

Continuing on this seasonality, we expect free cash flow to be stronger again in the second half of the year. We will continue to invest in research and technology and expect double-digit percentage increases.

Our 2019 forecast foreign exchange exposure is presently between 75% and 80% hedged. We estimate that a 5% movement in relevant exchange rates will have approximately a $3 million impact net of our hedges. Guidance is based on an effective tax rate of 24%.

I also want to highlight that we expect cash taxes to increase approximately $30 million compared to 2018, reflecting higher forecast income, reduced capital expenditures and fewer remaining prior period tax credits.

Lastly, please note following this call, there will be an updated investor deck posted to our website, which will include the 2019 guidance and supporting information.

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. In summary, Q4 and 2018 were marked by record sales, earnings per share and free cash flow. Hexcel is benefiting not only from aircraft program ramp-ups, continued adoption of advanced composites and strong demand, but also from our internal efforts to work more efficiently, continuously improve our processes, develop new and innovative products and position ourselves for growth.

Let me say it again: I am very proud of what our Hexcel team has achieved together. As we turn toward 2019, our markets are strong, with continued long-term growth and secular penetration expected. Our focus remains squarely on delivering exceptional performance to achieve great results. We're confident in our position as a global leader in advanced composite technology as well as our strategy to generate sustainable growth while creating ongoing shareholder value.

Sarah, we'll now turn it over to you. And we are ready to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Ken Herbert with Canaccord Genuity.

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Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace & Defense Analyst [2]

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Patrick, I just wanted to first start out on the 2019 guidance. If you could, I appreciate the color you gave on the incremental tariff impact. How should we think about the potential tailwind of gross margins from either France or the AN hedging program? It sounds like clearly the France facility will be a tailwind, but on the AN side, did I interpret your comments correctly to imply that you assume some sort of a flat impact from 2018 into 2019?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [3]

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Yes, that's probably the best way to look at it, and the fact that we're now hedging AN, we don't anticipate it to be a headwind that we would be talking about going forward. We would certainly minimize the potential for that. So we have essentially a flat position, if you like, built into our guidance. And we don't anticipate much movement from that on the AN front. And Roussillon, yes, very positive news. The plant is now aerospace qualified and producing aerospace-grade PAN and carbon fiber, and so that will be a significant improvement year-over-year.

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Kenneth George Herbert, Canaccord Genuity Limited, Research Division - MD and Senior Aerospace & Defense Analyst [4]

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And can you quantify at all what you expect an improvement to me? It looks like the guidance implies clearly about 50 basis points of gross margin improvement. Is most of that coming from the Roussillon facility?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [5]

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Well, a part of it's coming from Roussillon. Part of it is obviously coming -- the wind energy resin headwind is also behind us. And we've got some nice step-up in revenue programs, which is driving growth. And underlying all that, we continue to drive efficiencies and productivity throughout the business. So I wouldn't like to attribute the step-up just to one thing.

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Operator [6]

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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 [7]

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With regard to wind, it looks like it was obviously a huge number both for the quarter and the year. I guess, one, how should we think about kind of the lumpiness of that and the fourth quarter kind of unusual strength? And then, I guess, with regard to the repositioning on platforms and the benefit that you got in 2018, has that fully anniversary-ed itself, so that now, going forward, it'll more kind of evenly match kind of the overall wind demand? Or is there still some of that to come in 2019?

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

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I think the outlook certainly as we look at 2019, John, remains pretty strong. I think we expect to see more growth. I mean, we've highlighted double-digit growth for our Industrial business. And that is driven by wind energy. It can be a little bit lumpy. I mean, 2017 was a weak year for wind as you will remember. And the fourth quarter comparison is probably exceptional at 123% up. But we do expect significant growth again into 2019. So we see wind as a positive driver in the Industrial sector in the year ahead.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [9]

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Great. And then just a quick follow-up on the 777X. Certainly, a solid increase, and I know you were expecting at least something there. It seems like it's on a -- certainly on the high end of what we were looking for. Can you give us some color as to like where the bulk of that incremental contact or content is coming from?

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

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Yes, John. Certainly, the GE9X is a very composite-intensive engine for us. Both the engine and the nacelle. So the majority of our step-up or over 50% of the step-up was engine and nacelle related. Having said that, we also gained positions on structures for our matrix or prepreg position.

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Operator [11]

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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 [12]

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I was wondering, Patrick, on the financials looking forward. The $4 million to $5 million of tariff impact, that's in the guidance I imagine, and likewise, the $75 million implied share repurchases also in there as well?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [13]

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Well, the $4 million to $5 million of tariffs is in there. We didn't really call out a share repurchase number. I mean, what I will say on that front is we -- our objective is to maintain our leverage ratio in the 1.5 to 2 level as we've called out before. You will obviously be aware that we just paid $160 million for ARC Technologies, which went out in January, so that the first quarter of 2019. And within that framework, we would still expect to do some stock buyback, although we, obviously, haven't specified a number.

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Myles Alexander Walton, UBS Investment Bank, Research Division - Research Analyst [14]

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I was just going by the 50% return of cash flows that's more of a longer-term target versus your commentary?

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

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No. But, I mean, we still intend to meet that objective of greater than 50%. So...

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Myles Alexander Walton, UBS Investment Bank, Research Division - Research Analyst [16]

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Okay, great. And then the restructuring, can you just comment on what specifically it was and then how quickly that payoff is in terms of the move to EP for 2019?

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

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Yes. So the restructuring charge relates to our Belgian Engineered Products plant. It was a onetime action to improve productivity and efficiencies to ensure it remains competitive. That plant manages complex engineered core work for the European aerospace industry. The charge primarily related to employment costs, and we would see that payback over the next 2 to 3 years.

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Operator [18]

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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 [19]

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Patrick or Nick, it seems like you have a...

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

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Sheila, we cannot hear you. Sheila, can you speak up, please?

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [21]

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Yes, sure. It seems like you have several headwinds rolling off in 2019. What are their biggest inhibitors to further operating margin leverage as we look forward?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [22]

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I mean, so the challenge is for us to execute. I mean, you're right. So AN, Roussillon, wind resin are fundamentally behind us. Tariff is built into the guidance, and we will update as those do or don't change going forward. We are strongly hedged on FX. So we do our best to try to offset as many of the potential headwinds that we can see. Really, it's up to us now to execute, to drive efficiencies, productivities and to leverage the growth we have in a number of key platforms, the 350, the 787 and the narrowbodies, F-35 and wind energy. We have the opportunity. And as we've communicated, we will try to push margins as strongly as we can.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [23]

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And then maybe just one on CapEx. You're guiding flat CapEx year-over-year. Is there any way to quantify maybe what's maintenance versus expansion? And how do we think about potential new requirements of rate increases?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [24]

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I mean, in terms of maintenance, it's hard to be scientific as you have heard me say many times. $60 million to $70 million, I would say, is maintenance. The rest is growth. We called out in December 2017 we were putting in a fiber and PAN line in Decatur Alabama. That's a $200 million project. So you can imagine a chunk of the spend in 2019 relates to that project.

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Operator [25]

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Our next question comes from the line of Gautam Khanna with Cowen.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [26]

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Was wondering if you could quantify how Engineered Products margins move from the acquisition of ARC. What sort of the EBIT contribution that of the $4 million of incremental dollar?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [27]

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Yes. So I mean, we're just embedding ARC Technologies in. And so we're not going to give too many specifics at the current time. It's going to generate sort of just over $50 million in 2019, and we've said it's going to be accretive to EPS. It's within the Engineered Products segment, which has traditionally sort of been in the 12% to 14% margin range. If anything, it will be towards -- it will help move that range up rather than down. But it's still a little bit early to call anything specific out.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [28]

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Okay, that's helpful. And then just in Q4, if you disaggregate incremental margins, and I hate doing this all the time, but if you were to disaggregate it at Composite Materials, it was a little bit lower than what it was through the 9 months, through Q3. And I was just wondering you mentioned in the prepared remarks, Q4 of last year was kind of a rich mix. But was there anything else kind of onetime things that might be fading as we move into next year that dampened the incrementals at that segment?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [29]

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No. It was just a mix effect, Gautam. There is nothing particular. We've obviously called out and separated, adjusted out the restructuring, and that was in Engineered Products, in any case. From a Composite Materials, the headwinds we've talked about in 2018 was still there. They're obviously now going away as we go into 2019, which is very positive. But there's nothing particular I would point to other than sort of just a mix as it fell in the fourth quarter.

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Operator [30]

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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 [31]

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I think you mentioned R&D is going to be up double digits in '19. Any particular areas you're investing in? New fiber? Resins? Any new platforms that your R&D is targeting?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [32]

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Yes, Mike. Thanks for the question. We -- as you saw this year, we invested heavily. And similar to our plans going forward, it was broad-based, includes, obviously, next-generation fiber, new matrix and resin systems to enhance the processing of the materials for out-of-autoclave, faster cure rates. So there's not one, in particular, area. And I'd also have to point out that we spent a portion of our internal R&T on process enhancements to help throughput, to help optimize capital utilization and to help track productivity. So it's not one thing really drives it. It's pretty broad-based.

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Michael Joseph Sison, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [33]

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Great. And then in terms of ARC, just wanted to revisit, can you maybe talk about the sales synergy there or R&D synergy, really what that business brings to the table for you. And then the type of growth rate you think that, that business should generate over the next couple of years.

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [34]

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Yes. So we're really excited with the acquisition of ARC. The team there is fantastic. Their relationships, specifically in the Space & Defense and a lot of classified programs, is fantastic. If you look at what they do is they add value to composites for either RF, EMI, microwave, developing, absorbing materials that allow them to be used in broader applications. So the fact that ARC is predominantly a U.S. business gives us an opportunity to expand that technology and look at Europe and the rest of the world as a growth opportunity as well as take advantage of our customer context and our product portfolio to add value to our materials to continue to drive even more value and more function for our materials to our customers. So again, as you know, we just closed on the deal. We're integrating. We're sharing best practices, and we're really doing a technology review to see where we should prioritize our pursuits.

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Operator [35]

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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 [36]

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It looks like you picked up some share on 777X, particularly on the structures. You mentioned structure. Was that share you won from Toray?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [37]

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I don't want to get into who had it prior. Again, remember I mentioned that a big part of the gain was related to the GE9X engine and the nacelle that support that. So we certainly were successful on some matrix or prepreg opportunities on the structures and secondary structures. But I'll leave it at that.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [38]

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Is it fair to say it was a share pickup from somebody?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [39]

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That's fair to say. You know what? I wouldn't assume 100% of it because there can be some secular penetration, which we typically see moving from one platform to a new derivative. So you certainly can't say all of it.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [40]

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Got you, got you. When -- just kind of changing gears a little bit, it looks like this Boeing-Embraer deal is going to close at some point here. They got a bunch of hurdles behind them. When they do that and the OGMA business or the OGMA segment of Embraer in Portugal will end up being part of Boeing, and that's their composites center of excellence as you know, right, does that present an opportunity for you guys to maybe pick up some more business?

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

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Well, we certainly view it as an opportunity. It may surprise some that we've had a relationship with Embraer for almost 45 years now. And we're very close to them. We're very engaged. We have significant content on the E-series as well as the 390. So we've got great positions. I think with the Boeing involvement, that certainly can provide even broader opportunities for us.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [42]

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Okay. And then finally, maybe just one last question kind of down that Boeing vein. When we think about NMA 797, whatever you want to call it, can you give us some feel for how you're thinking about that as an opportunity? And also probably there's an A322 coming down the line or A321XLR, what kind of opportunity in terms of those new products do you have?

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

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Well, again we've said it before. Any time there's an upgrade to an engine, a derivative engine or even a derivative aircraft, there's more composite content. For a clean sheet, as NMA is being discussed, most likely, it's going to be very composite-intensive. And that goes for both the structure, the secondary structure as well as engines and nacelles. So we're working with Boeing. We're working with the engine guys. We're working with the nacelle guys. We are demonstrating our next-generation materials and processes for those applications. And I think for the NMA or for anything new that Airbus may launch, I think we've got a great product portfolio that offers significant advantages going forward. I'm a believer that the composite content will continue to go up as we continue to drive productivity and expand the ability to make more near-net shape. It just supports the secular penetration to continue.

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Ronald Jay Epstein, BofA Merrill Lynch, Research Division - Industry Analyst [44]

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And then finally, maybe just one last one. If we were to see one, two, both of those things roll forward, are you capacitized for that? Or would that require a future investment?

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

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So basically, if we are successful in what we hope to be, it's clearly going to require CapEx in the future. Our CapEx, as we're ramping up today, is pretty much accounted for. So any step-up in a new wing for a program or a new aircraft, in addition to the existing platforms, would be CapEx incremental addition for us.

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Operator [46]

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Our next question comes from the line of Rob Spingarn with Credit Suisse.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [47]

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Nick, I wanted to follow up on Ron's question there on NMA and then a couple of other things. But it seems that the time that this is taking for Boeing to make a decision has to do with the business case, and it seems like there's some challenging math on cost versus price. Now you guys have brought some innovation to composites. We think it's a composite airplane. How do we think about the dynamics of lower cost for composites on these -- on what would be a very new contemporary platform? Is there a way to think about it in a drop in price per pound, price per installed pound? We know out-of-autoclave might be part of the solution here, but how do we think about how meaningful your cost reductions can be here to help Boeing make this decision?

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

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Yes. So it's a combination. There's not a simple answer to it because basically, we're working on all fronts. So, for example, we have raw material modifications and options that could lower the material cost for the raw materials that the OEs buy or their subs buy to make parts. That's one element. A huge part, an additional element, is related to the processing cost. And again, it depends on which ultimate solution, whether it's out-of-autoclave, whether it's prepreg format, will determine how that -- what the split is with respect to raw material input cost and processing cost. I'd also say you cannot ignore or not take into consideration the lay-down rate of the material and how quickly parts can be made and how quickly they can be cured. So it's really broad-based. It's good for the composites industry because there's opportunity to eliminate scrap and to continue to expand margins because we're driving higher value for Airbus, Boeing and others, so that they can actually make the product at a lower overall cost.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [49]

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Is it fair to characterize your area as one of the greatest opportunities to reduce costs relative to something like 787?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [50]

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I don't know that I'd go that far. I think if you look at a relative comparison, we tell you how much the composite content is on an A350, which is very composite-intensive. Now you look at that versus an engine or various parts of mechanicals and systems, I don't -- I just wouldn't want to go there.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [51]

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Okay, fair, but that's helpful on that. Patrick, I have one for you on the cash conversion. So it's just quick math suggest that, that drops. If you're at 2 50 and I understand you might be higher, the cash from the 2 50 drops a little bit in 2019, and you called out the cash tax increase. Is that everything? Are there other puts and takes that we should be mindful of? If I back out the cash tax increase, it actually looks like your conversion would go up. So I just wanted to understand what the underlying is there.

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [52]

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Yes. I mean, we see the reduced CapEx levels of free cash flow continues to be strong, the cash taxes of about $30 million I mentioned. I would also say that working capital will go up, to some extent, as the business grows, with receivables and inventory being as managed as tightly as we can in terms of days, but there will be a step-up in working capital. And we'll probably have a little bit more interest charge. But fundamentals of the business to generate the cash is still strong.

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Operator [53]

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Our next question comes from the line of Paretosh Misra with Berenberg.

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Paretosh Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [54]

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Great. Most of my questions have been answered, but just to follow up on that, your new facility in France in Roussillon. So your guidance for 2019, are you assuming operating at full run rate for the entire year? Or, in other words, is there any maintenance? And are you fully booked to operate at that full run rate?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [55]

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Yes. So that Roussillon site is running 7/24 on both the PAN and the carbon fiber lines, and that material coming off of those lines is accounted for. So it's running flat out from the start of the year through the year.

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Operator [56]

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Our next question comes from the line of David Strauss with Barclays.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [57]

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So I assume it is, but is ARC included in the guidance that you provided today, the $50 million in sales and the incremental financing and the accretion that you talked about? That's all baked into the guidance you already provided?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [58]

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It is. It is.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [59]

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Okay. And then on depreciation. So I know it's stepping up another $20 million here in '19, Patrick. Does it step out -- continue to step up beyond '19 as well?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [60]

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Yes. I mean, as I sort of said, $4 million of that $20 million going into '19 is related to the ARC acquisition. So it would have been $16 million without ARC, which would have been a slightly lower step-up than we saw this year. But with the capital we've been spending in recent years, we still have some step-ups ahead of us, albeit that they will be coming down in magnitude as each year goes forward at the current level of CapEx.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [61]

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Okay. And then I want to go to the margin side of things maybe a little bit differently. So I think a while back, you used to provide an incremental margin target of around 25% incrementals. You, obviously, haven't hit that given some of the headwinds you highlighted. Would you say that, that 25% incremental margin range is somewhere back in play now given the absence of some of these headwinds?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [62]

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So, I mean, you would have picked up over the last year, we've moved away from giving specific incremental margins. There's very few companies that do that. And we found the performance and timing with headwinds and revenue platform builds, it was lumpy. And so we are just continuing to drive our incremental margins as strongly as we can. And we will push them as high as we can without a fixed target. We're not bounding ourselves, and we will hopefully at times, go above levels that have previously been targeted. So the outlook is good. Some key programs as I've said, the 787, 350, narrowbodies are all strong going into '19 year-over-year growth. The headwinds are going away. So it should be a positive incremental margin scenario.

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Operator [63]

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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 [64]

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I wanted to ask, do you expect the year-over-year rate of growth in your Commercial Aerospace business to be faster or slower in 2020 compared to 2019?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [65]

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So Noah, we're really not going to get into 2020 at this time. We're going to certainly provide more color on our longer-term outlook in all market segments when we host our Investor Day in Q2. As I said, we're very bullish on our positions. We're very bullish on build rates and the overall markets. And I'd prefer to hold off and give you that in Q2.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [66]

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Okay, fair enough. Patrick, just going back to the cash flow discussion you were having a few questions ago. The cash from ops has grown slower than the EBIT and the earnings a few years in a row, and you went through some of the moving pieces in that. I guess as we move out of this year, do those recouple? Or are there other things we need to be thinking about beyond this year that can keep those decoupled?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [67]

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Yes. Again, without getting into too long a term, I mean, we are seeing a step-up this year in cash taxes, which I wouldn't necessarily expect to repeat in the same magnitude. I mean, if the business grows, working capital will continue to grow. We'll obviously manage that as tightly as we can. Interest will grow a little bit as we maintain leverage and grow that a little bit. So the outlook should be strong. So the step-up in cash taxes, for sure, should not be seen as an annual expectation, Noah.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [68]

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Okay. And in the CapEx, you still have new facility efforts keeping the CapEx a little bit elevated this year compared to where it maybe goes in the future absent new aircraft developments. Is that fair?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [69]

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So yes, we certainly have capital in process. One of the big investments is in Decatur, Alabama, where we announced the next tranche of precursor and carbon fiber assets, which are being built as we speak. And those are scheduled to coming online in 2020 and 2021. So that's -- as you know, carbon fiber and precursor drive a big part of our CapEx spend.

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Operator [70]

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

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Krishna Sinha, Vertical Research Partners, LLC - Analyst [71]

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So you elaborated on a lot of your price/cost action. You talked about the tariffs and your acrylonitrile. You got to talk about your payback on the restructuring. Is there anything else that we should be focused on, on the cost side? I noticed that corporate expense was down quite a bit this quarter. So just looking at 2019, are there any further cost actions you're going to take that you have kind of outlined right now? Or is there anything we should have on our radar screen?

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Patrick Joseph Winterlich, Hexcel Corporation - Executive VP & CFO [72]

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Yes. So I mean, in terms of restructuring, no. I mean, it was very much a onetime restructuring activity. And we called it out. We haven't had a restructuring activity for several years, and there's certainly nothing else in the pipeline at the current time. In terms of the headwinds, as hopefully I've tried to put across, a number of them are going away, the acrylonitrile, the wind resin, the Roussillon start-up costs are behind us. Clearly, the tariff level we see is baked into our guidance. What happens next, we will be vigilant on and responsive to. And we are trying to achieve an exception to about 50% to 60% of the existing tariff charge that we're getting. So we will keep you updated on that. But no, I mean, fundamentally, again, top line growth with a number of headwinds moving away. We see a positive margin outlook. And there's nothing else, in particular, I would call out.

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Krishna Sinha, Vertical Research Partners, LLC - Analyst [73]

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Okay. And then I think Nick commented a little bit about the penetration in the engine and nacelles business on the GE9X and some other platforms. Can you just talk kind of bigger picture? What's kind of the overall market opportunity for you guys to take share from competitors, meaning not growth on entirely new platforms like the NMA but on existing platforms? Is there still a lot of room for you guys to just take share in aerostructures just by providing a composite alternative? Or are you kind of reaching the upper end of that limit and really the next leg up in growth is going to be from new platforms like the NMA?

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Nick L. Stanage, Hexcel Corporation - Chairman of the Board, President & CEO [74]

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So again, when you're talking about taking share, you have to remember that many of these parts and materials go into sole-source positions, where it's very difficult because of the qualification process, the time to qualify as well as the cost to qualify. So taking share from our definition, we're looking at secular penetration replacing metals, providing lightweight solutions and really driving that. For example, I'll give you one that is fairly straightforward, and that's engines and nacelles. As we are and improve our capability to drive our temperatures higher, we can go further back in the engine. Further back in the engine opens up more opportunities to replace high temperature alloy metals typically with composite solutions. So it's more about secular penetration and new platforms and not so much about displacing other composites.

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Operator [75]

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This concludes today's question-and-answer session. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.