Hexcel Corporation (HXL) Q4 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2018 Hexcel Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] I would now like to introduce your host for today’s conference, Patrick Winterlich, Chief Financial Officer. Mr. Winterlich, you may begin.

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. They involve estimates, assumptions, judgments and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the Company’s SEC filings and last night’s news release. A replay of this call will be available on the Investor Relations page of our website. Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be recorded or re-broadcast 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 fourth quarter and full-year 2018 results detailed in our news release issued yesterday. Now, let me turn the call over to Nick.

Thanks Patrick. Good morning everyone, and thank you for joining us today. Today, we are 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 in 2019. Let me being 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 undergoing 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 in 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 HXL team. I’m very proud of our global teams' 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 continuous focus on sustained operational excellence by driving productivity and process improvement that will lead to enhance 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 its full year of the Boeing 787 at rate 12. The transition to the Airbus A320neo and Boeing 737 Max accelerated strongly in 2018 and HXL benefited from both the increase shipset values of the Neo and Max compared to the legacy models as well as increased build rates for these narrow body 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'd member, 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 recovery of one demand in 2018, and our numbers yesterday proved that our technology innovations and efforts to reposition our materials for new and turbine blade, has been successful. Wind sales increased 67% year-over-year as our material was used for blades and a number of new turbines at our key Wind customer Vestas. Before I get into the 2019 guidance, I would 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 our Airbus, Safran and another 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 material science with the technology portfolio complementary to Hexcel and exceptional customer relationships particularly in Space & Defense. This acquisition combines two great research and technology teams to further develop next-generation products for space and defense and commercial applications. Now that the deal has closed, we are focusing and focused on growing the business and partnering with our customers to provide advanced material solutions for next generation programs and applications. All-in-all fourth quarter was a strong end of 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 wide-body production rate increases from 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 to continue to grow. Combined with the expected completion of the transition for the Neo and Max upgrades, we expect to see another year of strong growth for these narrow-body programs as well as production rate increases beyond 2019 which is an outlook supported by the 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 composite production 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 narrow-body engine and nacelles content increasing threefold and wide-body content increasing 50% for new and re-engine platforms. Space & Defense continues to be a leading adapter of the advance composites and Hexcel benefits from our diverse portfolio of applications that support more than a 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 roller craft, 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're pleased with its growth and are continuing to pursue new and expanded opportunities, not only in wind energy, but also in automotive and other industrial subsectors. Our industrial market provides a multitude of opportunities where advanced composites play a key role in solving light-weighting 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 anticipated headwinds. We remain optimistic for robust growth and continued secular penetration as I have outlined, and as a result the guidance we are issuing for 2019 reflects another strong 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 shares expected to be between $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 capacity 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 your growth 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 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.

Thank you, Nick. Fourth quarter 2018 sales totaled $561 million, an increase of 10.2% year-over-year. The full year 2018 sales were $2,189 million, a 10.3% increase over 2017. Our adjusted diluted EPS for the fourth quarter with $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 a $109 million, resulting in full year 2018 free cash flow of $237 million compared to a $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 influenced our reports results in some of the impacts may not be intuitive. The majority of our sales 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 pounds, our sales translates higher but our costs also translate higher resulting in net headwinds to market. Accordingly, we prefer strong dollar to a weak dollar. In terms of currency hedging, we employed a disciplined hedging strategy that lows in hedges over 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 headwinds to our full year earnings per share, compared to our original guidance was 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 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 Product segment. Industrial comprised 14% to the 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're substantially behind us as we move into 2019. First is that our Roussillon start-up costs are now behind us as the plant disqualifies, running 24/7 and delivering aerospace qualified PAN and carbon fiber. Next, the price of acrylonitrile which is 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 tariffs is the tariff that were introduced in 2018 and are now forecast to be at 2019 annual impact of approximately $4 million to $5 million. We’re actively pursuing exemption options to try to minimize this impact and we will provide updates as the year progresses, if tariff levels change. And finally is foreign exchange which I already addressed in 2018 and rebases for our 2019 guidance. As we entered 2019, we are greater than 75% hedged for both the euro and GDP 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 timing. Research and technology expenses increased $2.3 million or approximately 18% year-over-year, as we continue to invest in innovation, so we that we’re 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 a $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 one-time restructuring charges 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 Product segment which is comprised of our structures and engineer 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 margin for Engineered Products was 13.9% versus 12.9% in 2017. While the operating margin is lower than Composite Material segment, Engineered Products requires a much lower level of investment, generating returns on invested capital that is very attractive as those of the Composite Segments. The effective tax rate for the fourth quarter of 2018 was 24.2% for the year that 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 a $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 remained under our share repurchase program. Our capital allocation priorities continue to be investing in organic growth followed by targeted and discipline M&A, and we are committed to returning greater than 50% for our net income for shareholders through dividends and stock buybacks. In 2018, we returned a 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 broadcast to exceed $250 million. Capital expenditures are forecasted 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 forecasted to be higher in the first quarter of 2019 compared to the following quarters, reflecting the timing of recording of 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 relevance 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 credit. Lastly, please note, following this call there will be an update in investor deck posted to our website, which would include that 2019 guidance and supporting information. With that, let me turn the call back to Nick.

Thank you, Patrick. In summary, Q4 and 2018 were marked by record sales, earnings per share and free cash flow. Hexcel was benefiting not only from aircraft program ramp-ups, continued adaption of advance 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'm 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 a 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 will now turn it over to you and we’re ready to take questions.

Thank you. [Operator Instructions] Our first question comes from on line of Ken Herbert with Canaccord Genuity. Your line is now open.

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 interpreter comments correctly to imply that you assume sort of a flat impact from 2018 into 2019?

Yes, that’s probably the best way to look it at, and the fact that we’re now hedging AN, we don't anticipate 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 yet very positive news, The France is now aerospace qualified in producing aerospace grade PAN and carbon fiber and so that will be a significant improvement year-over-year.

Can you quantify all what you expect that improvement to be? I mean, it looks the guidance implies clearly about 50 basis points of gross margin improvements, is most of that coming from the Roussillon facility?

Well, a part of it coming from Roussillon, part of it obviously coming that there's a wind energy, resin, headwind is also behind us. And we 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 would like to attribute the step up just a one thing.

Thank you. Our next question comes from the line of John McNulty with BMO Capital Markets. Your line is now open.

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 the lumpiness of that and the fourth quarter kind of usual strength? And then I guess, with regard to the repositioning on platforms and the benefit that you got in 2018, has that filling anniversaried itself so that now going forward it will more evenly match kind of the overall win demand? Or is there still some of that to come in 2019?

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 by our industrial business and that is driven by wind energy. It can’t be a little bit lumpy. I mean 2017 was a week year for wind as you will remember and the fourth quarter comparison is probably exceptional at a 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.

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

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

Thank you. Our next question comes from the line of Myles Walton with UBS. Your line is now open.

Patrick, on the financial looking forward, the 4 million to 5 million of tariffs impact that's in the guidance, I imagine and likewise the $75 million implied share repurchases also in there as well?

Well, the 4 to 5 million is tariff is in the -- we didn’t really call out purchase number. I mean what I would say on that front is, we -- our objective is to maintain our leverage ratio in the 1.5 to 2 level as we 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 buybacks, although we obviously haven't specified a number.

I was just going by the 50% return of cash flows at more of a longer-term target versus your commentary.

No, but I mean we still intend to meet that objective of greater than 50%, so…

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

Yes, so the restructuring charge relates to our Belgian Engineered Products plant, it was a one-time action to improve productivity and efficiencies to ensure it remains competitive. That plant manages complex engineered co-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.

Thank you. Our next question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is now open.

It seems like you have a…

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

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

I mean, so the challenge is for us to execute, I mean, you are 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 trying to offset as many of the potential headwinds that we 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 narrow-bodies F-35 and wind energy. We have the opportunity and as we have communicated, we will try to push margins as strongly as we can.

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 with rate increases?

I mean in terms of maintenance, it's hard to scientific as you've 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 indicator, that’s a 200 million project. So, you can imagine a chunk of the spend in 2019 relates to that project.

Thank you. Our next question comes from the line of Gautam Khanna with Cowen. Your line is now open.

I was wondering, if you could quantify, how Engineered Product margins move from the acquisition of ARC? What sort of EBIT contribution net of the 4 million of incremental?

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

And then just, in Q4 if you disaggregate incremental margins and I hate doing this all the time, but if you were to disaggregation in a Composite Materials. It was a little bit lower than what it was through the nine months in Q3, and I was just wondering, you mentioned that the prepared Q4 of last year was kind of a rich mix. But was there anything else one-time thing that might be fading as we move into next year, that dampened the incremental that?

No, it was just a mix effect, Gautam. There is nothing particular. We obviously called out and separated adjusted out that the restructuring and that was an Engineered Products in any pace. From a Composite Materials, the headwinds we've talked about in 2018, was still there. They are obviously now going away as we go into 19, which is very positive, but there is nothing particular I would point to other than sort of just mix that fell in the fourth quarter.

Thank you. Our next question comes from the line of Mike Sison with KeyBanc. Your line is now open.

I think you mentioned R&D is going to be up double-digit in '19, any particular areas you investing in, new fiber, resins, any new platforms that your R&D is targeting.

Yes, Mike, thanks for the question. As we saw this year, we invested heavily in similar to our plans moving forward, it was broad base 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 is 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 drive productivity. So, it is not one thing really drives it, it's pretty broad based.

And then in terms of our just wanted to revisit can you maybe talk about the sales energy there or R&D synergy, really what that business based on the table player? And then type of growth rate you think that business should generate in the next couple years?

So, we're really excited with the acquisition of ARC. The team is fantastic, their relationships, specifically in the space and defense and a lot of classified programs is fantastic. If you look at what they do, as they add value to composite for either RF, EMI, microwave, developing, absorbing materials that allow them to be used in broader application. 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 take advantage of our customer contacts, and our product portfolio to add value to our materials to continue to drive even more value and more function for material to our customers. So, again as you know, we just close down the deal, were immigrating, were showing best practices and we are really doing a technology review to see where we should prioritize our pursuits.

Thank you. Our next question comes from the line of Ron Epstein with Bank of America. Your line is now open.

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

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

Is it fair to say it was a share pick-up from somebody?

That fair to say.

Okay.

You know what I wouldn’t assume 100% of it because it 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.

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

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 E-series as well as the 390. So, we've got great position. I think with the Boeing involvement that certainly can provide even broader opportunities for us.

And then finally maybe just one last question, kind of on the Boeing. 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 is an opportunity? And also probably, there is A322 coming down the line or A321XLR, what kind of opportunity in terms of those new products do you have?

Well, again, we said it before any time there is an upgrade to an engine, a derivative engine or even a derivative aircraft, there is more composite content. For a clean sheet, as the NMA has been discussed, most likely it’s going to be very composite intensive, and that goes for both, the structure, the secondary structures as well as engines and nacelles. So, we're working with Boeing, we’re working with the engine guys, we’re working with the nacelles guys. We’re 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 great product portfolio that offer significant advantages going forward. I’m a believer of that composite content will continue to go up as we continue to drive productivity and expand the ability to make more near-net shape it supports the secular penetration to continue.

And then finally just one last one, if we were see one, two both sort of things roll forward, are you capacitized for that or that require a future investment?

So, basically, if we are successful and 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 new aircraft in addition to the existing platforms would be CapEx incremental addition for us.

Thank you. Our next question comes from the line of Rob Spingarn with Credit Suisse. Your line is now open.

I wanted to follow up on Ron question there on NMA and then couple 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 costs for composites? And what would be a very new, contemporary platform, is there a way to think about it in a drop in price per pound, price for installed pound? We know out of autoclave might be part of this solution, but how do we think about, how meaningful your cost reductions can be here to help Boeing make this decision?

Yes, so it's a combination, there is not a simple answer to it, because basically, we are working on all fronts. So for example, we have raw material modification and options that could lower the material cost for the raw materials that OEs buy or there is subs buy to make parts. That's one element. A huge part and additional element is related to the processing cost. And again, it depends on which ultimate solution whether it's out-of-autoclave whether its prepeg 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 composite industry because there is 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.

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

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

Okay, fair. But that's helpful on that. Patrick, I have one for you on the cash conversion. So just a quick math suggested that drops, if you're at 250 and I understand you might be higher, the cash from the 250 drops a little bit in 2019 and you called out the cash tax increase. Is that everything or are there other puts and takes that we should be mindful? If I back out that the cash tax increase that actually looks like your conversion would go up, so I just wanted to understand what the underlying is there?

Yes, I mean we see, with the reduced CapEx level the free cash flow continue 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 day, but that will be a step-up in working capital, and will probably had a little bit more interest charge but fundamentals of the business to generate the cash is still strong.

Thank you. Our next question comes from the line of Paretosh Misra with Berenberg. Your line is now open.

Actually, most of my questions have been answered, but just got 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?

So that Roussillon site is running 724 on both the PAN and carbon the fiber lines, and that material come off of those lines is accounted for. So, it's running flat out from the start of the year through the year.

Our next question comes from the line of David Strauss with Barclays. Your line is now open.

So, I assume it is, but is ARC included in the guidance you provide 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?

It is.

And then on depreciation, so I know you’re stepping up another 20 million here in 19. Patrick, does it step up continue to step up beyond 19 as well?

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

And then, I want to go at 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% incremental. You obviously haven’t hit that given some of the headwinds you highlighted. Would you say that 25% incremental margin ranges is somewhere back in play now given the absence of some of these headwinds.

So, I mean, you would have picked up over the last year. We've move away from giving specific incremental margin as though few companies they do that, and we found the performance and timing with headwinds and revenue platform build, it was lumpy. And so, we discontinuing 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 are not bounding ourselves and we will hopefully times go above levels that previously been targeted. So, the outlook is good. Some key programs as I said the 787, 350, narrow-bodies all strong going into 19, year-over-year growth. With the headwinds are going away, so it should be a positive incremental margin scenario.

Thank you. Our next question comes from the line of Noah Poponak with Goldman Sachs. Your line is now open.

I want to ask. Do you expect the year-over-year rate of growth in your commercial aerospace business to be a faster or slower in 2020 compared to 2019?

So, no, 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 closed our investor day in Q2. As I said, and we are very bullish on our positions, we are very bullish on bill rates and the overall markets, and I'd prefer to hold-off and give you that in Q2.

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 re-couple? Or are there other things we need to be thinking about beyond this year and that's been keeping those things decoupled?

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, as the business grows working capital, we will continue to grow. We 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.

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 development, is that fair?

So, yes, we certainly have capital in process. One of the big investments is in the 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 come online in 2020 and 2019, so that's as you know a carbon fiber and precursor drive a big part of our CapEx spend.

Thank you. Our next question comes from the line of Krishna Sinha with Vertical Research. Your line is now open.

You elaborated on lot of your price cost actions. You talked about the tariffs and your acrylonitrile. You got to talk about your pay back on the restructuring. Are there -- is there anything else that we should be focused 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 are going to take that you have kind of outlined right now? Or is there anything we should have on our radar screen?

So, I mean in terms of restructuring, no. I mean, it was very much a onetime restructuring activity and we called it out, but we haven't had a restructuring activity for several years and there is certainly nothing else in the pipeline at the current time. In terms of the headwinds, as hope, they're trying 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 exemption to about 50% to 60% of the existing tariff charge that we’re getting. So, we will keep you updated on that. But now I mean fundamentally, again top line growth with a number of headwinds moving away, we see a positive margin outlook, and there is nothing else in particular I would call it.

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 aero structures 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?

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 likely solutions and really driving that. For example, I will give you one that is fairly straightforward, and that 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 in new platforms and not so much about displacing other composites.

Thank you. 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.