Hexcel Corporation (HXL) Earnings Call Transcript & Summary

Good evening and welcome to the Woodward and Hexcel Merger of Equals Announcement Call. As a reminder, today's call is being recorded. [Operator Instructions] For opening remarks and instructions, I would like to turn the call over to Kurt Goddard, Vice President of Investor Relations for Hexcel. Please go ahead.

Thank you, Brandy. And good evening, everyone. We appreciate your time and interest in Woodward and Hexcel and want to thank you all for joining us on a Sunday to hear about this transformational merger of equals. With me this evening are Tom Gendron, Chairman, Chief Executive Officer and President of Woodward; Nick Stanage, Chairman, Chief Executive Officer and President of Hexcel; and Don Guzzardo, Vice President of Investor Relations and Treasurer of Woodward. Please note that a slide deck is available to accompany this call on the Investors sections of both Woodward and Hexcel's respective websites. This slide deck, along with other important materials, is also available on our joint transaction website, which is woodwardhexcelmerger.com. Before we begin, let me briefly cover our safe harbor statement. Our comments contain certain forward-looking statements that are subject to the safe harbor provisions of the securities laws. These statements are not guarantees of future performance or events, and actual results or events could differ materially. I encourage you to take a look at Slide 2 of the slide presentation and our respective filings with the SEC for a discussion of forward-looking statements and the risks and uncertainties that could impact actual results or events. With that, I'd like to now turn the call over to Tom Gendron. Tom?

Thank you, Kurt. Nick and I are very excited to be here today to tell you more about this incredible combination and how it advances our common objectives to drive long-term growth and value for our customers, shareholders and employees. I've had the pleasure of working closely with Nick throughout my 10 years on the Hexcel Board, and I'm impressed with what Hexcel has accomplished under his leadership. Hexcel has developed strong customer relationships and its team creates innovative technologies that are transforming the aerospace industry. I truly believe that our 2 companies possess exceptional strength that, together, will create a powerful new company to drive future value. As a result of this merger, Woodward and Hexcel becomes a premier integrated system provider, focused on developing technology-rich innovations that deliver smarter, cleaner and safer solutions for our customers in the aerospace and industrial sectors. And bringing together these 2 industry leaders, we are creating a vibrant company that is well positioned to deliver technology advancements to create greater solutions for our customers and significant value for our shareholders. Woodward and Hexcel combined will build on our leading global positions in control solutions and advanced composites technology while benefiting from enhanced scale, a strong balance sheet and an unsurpassed portfolio of leading-edge technologies. Together, we have an impressive financial strength with revenue on a pro forma combined basis of more than $5.3 billion in 2019 and expected annual free cash flows of approximately $1 billion in our first full year. We expect to drive significant cost synergies, and we'll have a strong balance sheet, enabling disciplined and extensive capital deployment. In addition, our complementary cultures and talented teams, including our shared commitment to operational excellence and customer satisfaction, coupled with our enhanced financial strength position us to better serve our original equipment and aftermarket customers and to generate significant value for our shareholders. Now turning to Slide 5 in our deck, which provides details of the transaction. Upon completion of the merger, Woodward shareholders will own approximately 55% of the combined company on a fully diluted basis, and Hexcel shareholders will own approximately 45%. Specifically, Hexcel shareholders will receive a fixed exchange ratio of 0.2 -- 0.625 shares of Woodward common stock for each share of Hexcel common stock. Woodward shareholders will own the same number of shares in the combined company as they owned Woodward shares at the time of closing. The exchange ratio is consistent with the 30-day average share prices of both companies. The financial profile of the combined company is compelling. Woodward Hexcel will have a strong balance sheet with significant opportunities for enhanced revenue growth and consistent growing cash flows across our customers' program life cycles. Once combined, we intend to pursue an investment-grade rating, which we are confident the combined balance sheet will support. This financial strength and, in particular, the growing cash flows will support disciplined capital allocation priorities aimed at investing in the business to drive organic growth and returning capital to our shareholders. We intend to deploy cash towards share repurchases, which include executing on an expected $1.5 billion share repurchase program within 18 months of closing. We also will have an initial dividend yield target of 1%. To align with this target, Woodward is increasing its current quarterly cash dividend to $0.28 a share, effective with our next dividend payment. We expect to realize more than $125 million in annual cost synergies by the second full fiscal year post closing. We also envision significant opportunities for cross-selling benefits through enhanced customer relationships and by combining research and development efforts. From a leadership perspective, Nick will serve as Chief Executive Officer of the combined company, and I will serve as Executive Chairman. After more than 30 years of service with Woodward, I expect to retire in 2021 and then continue to serve on the Board of Directors after I retire. I have the utmost confidence in Nick and his ability to lead the combined company. Nick's judgment, collaborative style and values are a perfect fit for Woodward. Nick and I will both serve on the combined company's Board of Directors, which will have a total of 10 members with 4 additional directors from each company. Our new company will be called Woodward Hexcel, and company headquarters will be in Fort Collins, Colorado. This transaction is subject to Woodward and Hexcel's shareholder approvals as well as other customary closing conditions, including required regulatory approvals. We expect the transaction to close in the third calendar quarter of 2020. Before I turn the call over to Nick so he can share his perspectives on the bright future of this premier company, I would like to remind those on this call that we will report our first quarter 2020 financial results on February 3. For those who are not familiar with Woodward, we do not provide quarterly guidance. However, we are in line with our expectations for the quarter. Now over to Nick.

Thanks, Tom. Along those same lines, I'll remind everyone that Hexcel will report fourth quarter and fiscal year 2019 earnings on February 3 after market close. In advance of our earnings release, I'm confirming that we are in line with our previously provided guidance and cash came in strongly. I will not make further comments on Hexcel's Q4 earnings today. Moving on to Slide 6. Let me start first by echoing Tom's excitement for this combination. This is truly a merger of 2 highly successful and dynamic companies that are joining together to create even more shareholder value. As many of you already know, both Woodward and Hexcel are top-performing companies in their own right with broad portfolios of leading-edge products with intimate customer relationships. We both invest heavily in research and development. And we both focus on continuous improvement through operational excellence. Both our companies have talented employees committed to working safely and delivering exceptional value to our customers. I recognize that some of you may not be as familiar with each company. So let me provide brief overviews. Hexcel is a material science technology leader, providing advanced composite materials to aerospace, space and defense, and industrial markets. As a technology leader, we produce a broad range of materials from carbon fibers and reinforcement fabrics to resin systems and prepregs, honeycomb and engineered products. Because our composites are stronger, lighter and more durable than bundle-based products, we offer exceptional value to our customers. Moreover, our lightweight products enable our customers to improve aerodynamics, which leads to reduced fuel consumption and lower emissions, and our proprietary Acousti-Cap honeycomb core, reduces noise significantly. All of these technological advances are meeting the growing challenges faced by aerospace and industrial customers. Now let me turn to Woodward. In my professional life, prior to joining Hexcel, I've known and even competed against Woodward, and I have the utmost respect for the company's products and people. Woodward has a rich 150-year history of focusing on designing innovative control systems solutions for niche markets in aerospace and industrial. Woodward's fundamental technologies are around fluid control, combustion control, power control and motion control. They use those technologies and apply them to solving pressing industry challenges around emissions, efficiency, energy independence and safety. Combined, Woodward Hexcel will be in the forefront of delivering advanced solutions, leading to improved aerodynamics, energy efficiency, safety and lower emission technologies. Turning to Slide 7. Woodward Hexcel will benefit from the enhanced scale our 2 companies will have. Together, we will be one of the largest independent aerospace and defense suppliers in the world with leading technology portfolio and significant positions on all key aerospace programs. Additionally, as you can see at the bottom of this slide, the transaction combines both companies' exceptional original equipment positions with a strong aftermarket business. Hexcel's secular composite penetration and Woodward's industry-leading aftermarket positions will provide tremendous breadth, which creates a strong complementary balance of long-term consistent cash flow generation across program life cycles. As we think about the aftermarket, the fundamentals are strong. Commercial airline passenger growth and aircraft utilization are robust and forecasts are calling through enlarged fleet expansion globally over the next 20 years. All of these trends reinforce continued growth in our aftermarket opportunities. Looking specifically at aerospace on Slide 8. The combined company will offer customers complementary and integrated technologies from nose to tail. As you can see from this illustration, Woodward and Hexcel touch nearly every aspect of aerospace design. As a result, we will be well positioned to provide more complete solutions for our customers, delivering integrated systems that satisfy demands for aircraft aerodynamics, energy efficiency, improved safety and reduced emissions and noise. Further, given the significant level of R&D investment we are committed to, the combined company will be strongly positioned to support next-generation aerospace customer programs and to accelerate innovation to enable aerodynamic and propulsion efficiencies. We see significant opportunities to drive greater penetration and innovation in integrated propulsion systems in particular. Woodward Hexcel will be a premier systems provider for engines and nacelles, which is a critical focus area for our customers, and provides a tremendous opportunity for us to deepen our relationships by driving innovation in one of the most important elements of the aircraft with respect to fuel efficiency and emissions reduction. We'll also look to explore new opportunities to add value through a combined focus on other technology-rich innovations. To name a few, accelerated composites adoption, enhanced noise and thermal suppression and sensor and control integration. From a customer perspective, Woodward Hexcel will have an incredibly broad and deep exposure across the premier platforms in aerospace, defense and industrial markets. This includes providing significant content for leading aircraft programs expected to be in operation for decades to come. Both Woodward and Hexcel have very attractive industrial businesses, which together would have generated pro forma sales of approximately $1.3 billion in 2019, as shown on Slide 11. Both our companies share a similar strategy within Industrial, and that is leveraging our strong R&D investment, innovative technology and expertise across strategic industrial markets to drive incremental development opportunities where returns on invested capital are consistent with aerospace returns. Whether aerospace or industrial, both Woodward and Hexcel are working to support the drive to develop more environmentally friendly air travel and power generation as fuel efficiency and lightweighting continue to gain urgency and greater importance with our customers and with the owners and operators. Turning to Slide 12. At the core of our 2 companies is a clear history of dedicated technology innovation. Together, we intend to accelerate those efforts through our enhanced scale and combined research and development capabilities. We expect Woodward Hexcel to spend $250 million on R&D in the first full year following close. This will ensure that we are strongly positioned to address rapidly evolving industry and customer needs around improved aerodynamics, propulsion efficiency, lightweighting, emissions reductions and energy efficiency. Independently, each company has focused on developing innovative solutions for a broad range of sectors and products. Together, we can target significant and exciting joint development opportunities within specific areas of focus for our customers. Beyond the strategic and financial benefits, both Tom and I are confident our 2 companies are a great fit from a cultural and values perspective. Both companies have similar cultures with a shared commitment to safety as well as a relentless focus on meeting our customers' expectations for perfect quality, on-time delivery and continuous improvement. Our ability to accelerate innovation and growth while exploring new opportunities for technological advancement will be enhanced by our company's complementary cultures. Woodward's constitution is based on respect, ethics, teamwork and initiative, and it pairs well with Hexcel's long-standing values of innovation, accountability, responsibility and operating as one company. Both companies have outstanding track records of operational excellence and value creation. Now turning to Slide 14 to summarize the compelling financial benefits of the merger. For our respective 2019 fiscal years on a pro forma basis, Woodward Hexcel would have more than $5.3 billion of revenue, EBITDA of more than $1.1 billion and EBITDA margin of 21%. Combined free cash flows for the first full year post-closing are forecasted to be approximately $1 billion. And as we mentioned, these cash flows will have greater consistency and stability across product life cycles. Woodward Hexcel will also have an exceptionally strong balance sheet with an expected leverage ratio at closing of approximately 1.4x debt to trailing EBITDA. We intend to seek investment-grade rating for the new company, and we are confident in achieving based on our strong combined balance sheet. Woodward Hexcel will have the financial strength to pursue significant growth opportunities going forward and create significant shareholder value. Turning to Slide 15. We expect to generate more than $125 million of cost synergies by the second full fiscal year post closing, creating significant value for our shareholders. These cost synergies are clearly identified and achievable, and we expect them primarily in 3 areas, including corporate costs, SG&A, and cost of goods sold. We also anticipate revenue synergies for the combined company through greater depth and balance of customer relationships across the aerospace and industrial sectors with significant opportunities for cross-selling. We will enhance customer relationships by accelerating innovation and integrating our advanced materials and control solutions to deliver smarter, cleaner and safer technologies. Now let me turn it back over to Tom for some final comments.

Turning to Slide 16. Strategically, culturally and financially, this transaction will deliver significant benefits to all of our stakeholders. For our customers, Woodard Hexcel will accelerate innovation through greater scale and combined R&D capabilities. We will be positioned to deliver solutions that improve aerodynamics, energy efficiency, safety and lower emission technologies. For our investors, the combined company will have a strong balance sheet and generate significant free cash flow with a disciplined capital deployment strategy to drive sales growth and enhance value. And for our employees, this transaction will create new opportunities for growth and development as part of a larger organization, one that combines two similar cultures with shared values and a focus on excellence. This combination will be truly transformative for both companies and highly beneficial for our stakeholders. And in the coming months, we will be working hard towards closing the merger and setting the groundwork for seamless integration of our 2 companies. So to wrap it up, the future of flight and energy efficiency will be defined by next-generation platforms delivering lower cost of ownership, reduced emissions and enhanced safety. Combined, Woodward Hexcel will be at the forefront of this evolution. We will be a leading aerospace and industrial supplier, well positioned to deliver state-of-the-art technologies to address evolving customer needs. Our greater scale and combined R&D capabilities will help us accelerate innovation in aerodynamics and energy efficiency. Our business will generate robust cash flow, further enhanced by significant cost synergies all the while returning capital and delivering value for our shareholders. And before we open up the lines for Q&A, on behalf of Nick and our leadership teams, we want to thank the employees of Woodward and Hexcel, who have been and will continue to be the foundation of our success. We look forward to their innovative contributions to Woodward Hexcel as we move ahead together. With that, we are happy to take your questions.

Thank you. [Operator Instructions] Your first question comes from the line of Sheila Kahyaoglu of Jefferies.

Congratulations on announcing a deal, and now I know what Bob is up to. So that's helpful.

Well, thanks, Sheila. Yes.

I was wondering, can you walk through your free cash flow target of about $1 billion annually, starting in maybe 2021, because we're ending up 15% below that. Are there any moving pieces maybe you could walk us through?

I don't think there's any moving pieces. As we're finding our outlook, and as you know we're bringing the 2 companies together, what I would say is, we're getting the full cash flow numbers that we anticipate and add the synergies into that cash flow number and you get right about $1 billion.

Okay. Maybe I'll walk through that off-line. And then I think R&D is slated to be $250 million or up 15% from where you guys ended 2019 levels. So you mentioned some cross-selling opportunities or benefits in the opening remarks. And just given there aren't any new upcoming aerospace platforms coming up in the next -- in the near term, how do you think about those cross-selling opportunities and the revenue synergies?

Yes, Sheila, this is Nick. So for starters, $250 million was the number that we cited, and we're confident we're going to spend at that level. If you look at our relative customers, we have certain customers where we are very embedded and very strong, even more so than Woodward and Tom's team. Clearly, those will create opportunities, maybe not on new platforms but cost initiatives, productivity initiatives and functionality initiatives that are always going on in the aerospace customers as well as industrial. So we feel very good in the shorter term on cross-selling opportunities and then clearly, in the medium and long-term on adding functionality, adding capability to integrated systems and combining our powers and portfolio -- breadth of portfolios.

Your next question comes from the line of Robert Spingarn of Crédit Suisse.

I wanted to ask you both if you could give us a little more background on the genesis of all of this. When you started discussing it, what was the initial impetus strategically? And then I have a follow-up.

Okay. I'll take it first and then let Nick add on to it. For a long time, Nick and I have worked together. We've traveled together. We've gone to industry events, customers. And really, what we saw -- or see happening over the last year, in particular, is huge pressure on the aerospace industry to reduce greenhouse gas emissions. As we started looking at that and looking at the work we're doing, we're both really focused on improving propulsion efficiency, improving aerodynamic efficiency, lightweighting the aircraft, and it's all targeted there. So when we started looking at that, we're really pursuing the same initiatives with the same customers. And looking together, we think, near term, we can bring some value. But as Nick highlighted earlier, with our R&D investment in the mid and long term, we think we can bring some really advanced solutions together that are going to hit these critical issues that the industry is facing. And I think that's a unique opportunity that our 2 companies can bring to the industry.

Yes. And just to add to that, we've been looking at our portfolio and opening up our aperture, looking a little broader on how we can provide bigger solutions to solve more of our customers' challenges going forward. And there are some areas that are very attractive and adding functionality to materials where you can improve properties around noise or thermal management or radar absorption or conductivity. And sensing is certainly a key element and being linked to controls technology is a big element, and it just really started to become obvious that this was a combination that made total sense.

So on that, Nick, just -- is there a clear vertical relationship between any of your products -- when I -- you went through Slide 7 and you showed us both companies all over the airplane. But are there some particular systems where you're both there and there's that vertical relationship?

Well, if you look at specifically, and I can't remember the page, but the engine and nacelle page, where the Woodward controls are front-to-back, thrust reversers, engine controls, air valves, sensing, we're pretty much front-to-back as well on Acousti-Cap and blades and materials to provide lighter solutions. So there's definitely an interface, but I would point out, these are complementary, and the real opportunity is finding ways to incorporate and get them into systems and -- as well as providing bigger solutions for our customers.

Yes. And maybe I'd just add to that is that you have this channel synergy that then were evolved into technical synergy as time goes by and that we really see, that's where the industry is going. So we're going to take advantage of both that in the near term and more enhanced technology synergy over the long term.

Okay. And I just wanted to go back to clarify something Sheila asked about, which was the $1 billion. And I understand there's synergies there, and there's some growth. But when I look at the consensus out about a year from now, 2021, I get to about $750 million. And then you've got $125 million in synergies, I don't know if it's -- I guess it's all there by then. But how do we get from that, call it, close to $875 million up to $1 billion? Is there something else? Is there some working capital or something else we should be considering?

I think what you'd have to look at is, Rob, in our -- each of our internal plans, we've got enhanced earnings, we've got improved working capital. We have lower CapEx coming between the two companies, and we've got the synergy savings. So when you put it all together, our outlook's forecasts are raising up to that number.

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

This is actually Lou Raffetto on for Myles. How are you?

Good. Thank you.

So I'm going to sort of just circle back on the cash flow. So is there -- is the $125 million a net number or is that a gross number of synergies, I'm sorry.

So that's a gross number.

Okay. And is there any cost estimate you guys have, I guess, with you?

We have -- our teams, both Tom and ours at Hexcel, we have done a lot of work and vetted the cash, and we're very confident of achieving $125 million plus. So the costs, they have...

I'm just wondering that...

They have a good understanding of that, and you consider it's less than half the synergies that we're reporting in the $50 million range.

For the cost, you're saying?

The cost.

Okay. And then, obviously, this is a sort of a precarious time for the supply chain, especially on the OEM side. So I'm just curious how are you guys or how did you consider the 737MAX in this plan?

Yes. As we look at the industry, obviously, the MAX is a major issue for a commercial aerospace. What you'd have to look is, we're on that program. It's a good program for both companies, but our portfolio is huge. We're on all the major applications. We're looking at as that comes forward. But the current OEM program, the broad base, plus really a robust aftermarket together, we're going to move right through the disruption that program caused.

Yes. I would just add, the genesis of this project and Tom and I realizing that it made total sense was not dependent on a specific segment or a specific program. These are long-cycle businesses. They are businesses that we invest in for the next 5, 10, 20-plus years. And we are confident that this combination is going to be good for our shareholders, our employees and, most importantly, our customers.

Your next question comes from the line of Gautam Khanna of Cowen.

I'm sorry to keep harping on this cash flow build. But just to be clear, it's not a full $125 million that you're assuming in that $1 billion in year 1, correct? It's some number below that. But the sum of the 2 stand-alones, therefore, would probably be over $900 million. Is that what you're sort of implying? I just want to be clear on that.

That's correct. Yes.

Okay. And that's considering the [ 8 7 ] cut and the [ 3 7 ], maybe a more shallower return to [ 57 ], a more prolonged return. Is that fair?

It is factoring our estimate of the market in the production rates. So that's correct.

Okay. All right. Separately, is there any -- can you talk about, is there any breakup fee associated with the deal, a? B, is there any consequence to the GE JVs that Woodward has? Could they -- could this trigger a put or anything? Is there any sort of risk to sustaining that JV relationship? And thirdly, any plans with the non-aero industrial business to be jettisoned later? Or is this going to be part of the ongoing portfolio, if you look out 5 years or what have you?

Okay. So I'll take part one. There is a break fee. It's the same going both ways. It's $250 million. Tom, I'll let you take the GE joint venture.

Okay. With the GE joint venture, this will not impact that. And I believe this combination will be very -- be viewed very favorably, and we'll continue, and we're very pleased with that joint venture with GE.

Okay.

The other one maybe I'll comment is on the Industrial markets. We like our Industrial businesses. They -- if you really take a look what we do in our Industrial businesses at Woodward and really at Hexcel as well is the same thing we do in aerospace. The end form factor is different. But the technology, the application, the drivers of efficiency, emissions reduction, lightweighting are all the same. And we think we have premier industrial businesses, and we think they're a solid part of this merger.

Okay. And forgive me, 2 more. Just on R&D, the $250 million, how does that compare to the stand-alone's plans for 2 years out? Is that a bigger number? And if so, by how much?

It's in line, acknowledging that we've already identified. We want to do some things to take advantage of the integration opportunities of pulling the 2 businesses together. So there's certainly incremental additions included.

Okay, that's good to know. And then -- so a little bit of -- you're just saying it's a pull forward. It's in line, but there's a little bit pull forward from -- it would have been $240 million or something thereabouts?

Yes, there's a little -- there's some incremental to propel the new technologies forward. But you take back -- it's robust, the amount of R&D. And I think our 2 companies and our heritage is about strong organic growth and serving our customers, solving their needs, solving their challenges and needs. We're committed to that same approach going forward.

Okay. And then my last one, forgive me, again. This buyback of $1.5 billion over 18 months, so I was just curious, what the logic is of putting that number out there? Committing to that so far in advance, is it to just signal that M&A -- further M&A is not going to be a priority or, I'm just curious why?

I'll comment, so will Nick. I think the first thing to look at is both companies are generating really good cash flow. It is going to take some time to do integration. We're going to generate a lot of cash. We're going to return that cash to the shareholders while we're getting the business integrated. After that, we're going to still have a fabulous balance sheet. And at that point, we'll be investing in growth and other -- organic growth and other growth opportunities.

Your next question comes from the line of David Strauss of Barclays.

I guess going back on this cash flow build up, I guess, do you have any target for the combined company from a CapEx standpoint. I think Hexcel running around 6% of sales and Woodward closer to 3%. Is it right to think that it's going to be below the -- the average of the 2, the combined company?

So David, as I think you know, both Woodward and Hexcel have just gone through very large CapEx investment to facilitate -- to support the growth in the marketplace on the refresh on composites, the new market positions that were won with respect to controls. And we've gone through that investment cycle. So with respect to the percentages, again, we haven't provided guidance for 2020 yet. But as we indicated earlier, our CapEx spend will be going down. And it will be dependent on new opportunities and new applications that we can identify.

And at our Investor Day in December, for those that attended, you also saw that we highlighted that we will be coming down to a lower CapEx over the next 5 years, more in line with maintenance. And that, as Nick pointed out, because we made strong capital investments to support future growth, and we feel like we're in this return cycle because we both have invested heavily, and that's part of the cash story.

Okay. And then from a revenue synergy standpoint, I guess, touching on the aerospace side, is the nearest term opportunity you feel like on the engine side from a revenue synergy standpoint?

I think when we look at the revenue synergies, the first is that we do, I really believe, have some channel synergies. Hexcel has a tremendous aerospace sales force in Europe and great relationships. We're confident we're going to be able to leverage those into near-term sales. And there is a demand in the market to do upgrades to the current aircraft, the current aircraft manufacturers are looking to get cost out. They're looking at upgrades, improvements, some derivative activity. So we think we'll be able to pull sales through there. Mid-term, when we go into, whether it's an engine manufacturer or an airframe manufacturer, we believe we could package solutions together and bring some value to our customers. Longer term, we're going to bring new revolutionary type technologies and integration, especially around aerodynamics and propulsion efficiency. And we think through that, we're going to have growth across the near, mid and long term. And we do believe we can leverage each other's sales channels to drive growth.

Okay. And the last one for me. On the MAX, have you, I guess, or either one of you, have you heard from whether it be Boeing or CFM, how this is going to come through and potentially impact you guys? Is it going to be the pause I'm speaking of? Would you expect the pause, either one of you expect the pause or come down pretty meaningful in terms of rate over the near term?

I think we really have to wait to see Boeing's announcements on their plans. And then we'll be able to respond at that time.

Yes, I would just say, obviously, we're looking at scenarios, and it's being evaluated, not only Boeing's build plan and estimated return to service, but also the response and effects in the supply chain. So...

Your next question comes from the line of Michael Ciarmoli of SunTrust.

Maybe just to stay on the MAX and stay on the cash flow, I mean, Spirit basically just cut 21% of its workforce, and it certainly seems like production rates are going to be in the 40s for the next couple of years. Does that have an impact on your cash generation? If we're at a production rate of a 40%, you guys have obviously invested the CapEx to support 57%. There's probably going to be some excess overhead. I mean, is there opportunities to look at excess capacity and facilities that you have? Just trying to get maybe more of the thoughts on your sensitivities there.

Yes. One of the things -- when we get the new production rates, we'll be able to better answer question. But one of the things with a lower MAX production rate will mean larger aftermarket sales for us. So we could redeploy both our capital and our people to address that. So there's opportunity to move as well as support any larger ramps by Boeing's competitors. So I think there's that opportunity. And we are able to flex on the resources. And I'll let Nick kind of comment on the ability to leverage on Hexcel.

Yes. Again, and both Tom and Woodward as well as Hexcel, we have a huge focus on operational excellence and continuous improvement. And there's no question, both of us are driving for improvements in working capital, inventory management and quick returns. So that's clearly a focus. And to speculate on what Boeing is going to end up with, what the regulators are going to ultimately approve, there's not a huge value in doing that, other than to say, we, along with Woodward, are very connected to Boeing. We're very aligned with Boeing, and we will respond very quickly to make sure we can optimize our performance.

Okay. Does that -- I mean, what have you guys -- can you tell us what rate you've assumed in that $1 billion cash flow? Or do you guys think you have enough levers to pull that it doesn't really matter, you're confident in getting to that cash flow, even if we never see 57%?

I think we have the flexibility to adjust on that. And we have, as Nick said, scenario. So I don't think we're going to go into anything until Boeing releases their numbers.

Okay. And then maybe, Tom, how much -- can you quantify how much you're purchasing, if it's meaningful, from Hexcel today to incorporate in some of your -- whether it's component solutions, it sounds like maybe on thrust reversers, maybe you're an acquirer of some of their material, but is it that meaningful today?

No, it is not. It's really the opportunity to bring the technologies together for new innovative solutions. And we've -- we're both working on challenges from our customers. We're working on the same projects, and we see, as this goes forward, the opportunity to bring those technologies together to bring better solutions. So it's not a vertical play.

Yes. Got it. And then last one for me. Should we think about this -- I mean, it seems like we should, I guess, the 21% pro forma EBITDA margin, that clearly seems to be a floor. Should we think that there's room for margin expansion on a go-forward basis? Just how do we think about margins over the longer-term here?

Well, you're stealing my message to our operations team, because certainly, as an operational-focused organization as Woodward is and as Hexcel is, we will be looking to improve our overall performance and to drive margin expansion. So I'm not going to say it's the floor, but I'm going to say we're looking for expansion from that point.

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

Yes, I just have one left, and it's on the synergies. In terms of the 3 buckets that you outlined, I guess, is this something where we should be expecting roughly the same level from each or is 1 bucket maybe a little bit more heavily weighted? I guess, how should we be thinking about how the synergies are broken up?

Yes. Right now, I think it's not equal between the 3 buckets, but it's meaningful in each category. I think that's as far as we're disclosing at this time.

Okay. Fair enough. And then, I guess, maybe one thing tying to that. From a working capital perspective and in terms of some of the potential buying overlap, if there's any, do you see working capital synergies as well for the business? Or is it really just they're separate enough in terms of the verticals where that's not necessarily something we should be thinking about or counting on?

Well, I definitely feel there's synergies in our sourcing and particularly the indirect areas that I think we can enhance. Both Nick and I have working capital improvement programs in place right now and driving forward. We see the opportunity as individual companies and together to continue to drive improvement in that area.

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

Just maybe circling back on the technology side. So are you thinking that you could maybe take the application of Hexcel materials and use them at Woodward systems? I'm just trying to get my head around where you get the technology synergy, where it would come from. Because from my vantage point, it just seems like you guys have really no overlap whatsoever. So I'm just trying to get my head around how you're thinking about that.

So we look at it twofold, Ron. Take our additive manufacturing and you look at the discrete systems and components that Woodward make, there are clearly opportunities for us to add value in displaced models and provide lighter weight solutions going forward. From there, if you look at some of the opportunities to think about adding value with sensing, adding functionality for the materials and bringing those together, those were more of the medium-term opportunities that Tom was talking about. So we think there are opportunities at the system integration level. And there's also opportunities to some extent on incorporating our composites in their current product offerings.

Right. And then in addition, one of the things we're looking at is when you look at a new advanced wing of the future, the integration of the control surfaces and the composites can be very different. And we think there's opportunity on that integration as well. So that's where we go to a little longer term on how the materials, the composites come together. Around the engine, we see with some more advanced engines. In the nacelles, you see more integration there. And just the ability to go on to customers and show constant solutions that come together, we think there's leverage on that.

Got you. Now another question, kind of changing gears a bit. In the combined company, do you think there's going to be any need to divest of anything? Or is there anything in the Industrial area that once you have this critical mass of aerospace stuff, just really seems just very noncore at that point?

We always look through -- I'll speak for Woodward, and I think it's the same for Hexcel. We always look at our portfolio and manage the portfolio. But when you really take a look at the Woodward Industrial business, a great majority of all that business has -- is doing the exact same thing around the control systems. So it's fuel controls, combustion control, motion control systems. The technology leverage, we move things back and forth between the aerospace and industrial. We think there are really strong industrial businesses, top quartile-type businesses. So we think there's value there, but we will continue to look at our portfolio. And over time, as part of integration, see if there's anything strategically we want to address.

Yes. And from Hexcel side, very similar. The technology and the material science that we deploy in the Industrial business is virtually the same as we do in the aerospace. So there's tremendous advantages to have that technology go back and forth. And the other point is we're very selective in what we pursue in the industrial segments. As we said, we're not trying to be everything to everybody. There are niche opportunities where we can provide sustainable competitive advantages.

And maybe just again, changing gears again, one last question. Have either of you had conversations with anybody else around this? One of the questions we all get is, who else can get involved with this. I mean, has this just been the two of you talking? Or has it been a more complex transaction?

I think we have looked strategically at the industries, at strategic arrangements, and we really have come together, [ I think ]. When we look at where the future of the aerospace industry is going, this combination makes tremendous sense. And we're confident it's going to bring great value to our shareholders. So we're always looking at it. And we think this is the right move that...

We -- I'd just add to that. We think our position and leadership in advanced lightweight materials is a natural fit with Woodward's controls, sensing and their technologies throughout the engines and airframes as well as industrial. And the timing is right from our perspective.

Your next question comes line of Paretosh Misra of Berenberg.

Most of my questions have been already asked, but just to go back on the last one. Is there any longer-term plan for the non-aerospace business? In other words, maybe you would like to just increase the aerospace exposure and divest or spin-off the Industrial business altogether?

These are -- as we just were highlighting, we think there's a lot of synergy across our aerospace and Industrial businesses and the ability to leverage back and forth. So at this time, there's no intention whatsoever to spin-off Industrial.

Totally agree. I just going to reiterate, I totally agree. Clearly, we'll have a strategic planning process. We'll always look at the market dynamics, our customer needs, and we're going to continue to look for ways to enhance our portfolio to continue to build more capability to provide our customers even bigger and broader solutions.

Got it. And then the real quick -- I don't know if you've disclosed that, but for Woodward, who's the biggest customer?

Well, Woodward, it will be between Boeing and GE.

Your next question comes from the line of Chris Olin of Longbow Research.

Is there a way to think about the revenue content for the 737MAX once the companies are combined? I know Hexcel is probably around $400,000 per ship set. I'm not familiar with Woodward. Is there a number you're giving out?

Yes, we're -- go.

I was just going to say, I believe, and Tom will confirm me, but we both publicly disclosed those. And Tom, I think you're $300,000. So roughly, we're on the order of approaching $750,000 per ship set.

Okay. And just to make sure I'm clear on the timing, I guess, my question would be for Tom. How did you get comfortable with the valuations that were applied when there are so many uncertainties out there? For example, what if the FAA takes an extra 3 to 4 months to approve the MAX. Is that in your thinking?

I think it was -- it has -- there's definitely a real merger of equals. We went through the valuation with the assumptions, looking at each other's financials and the sensitivity around them. And we think we came to a market-based valuation with no premium, and we think it's appropriate and takes into -- all those factors were considered.

With an incredibly strong balance sheet going forward.

Your next question comes from the line of George Godfrey of CL King.

Congratulations on the merger announcement. Tom and Nick, at the risk of beating the dead horse, but I'm going to beat it. If -- Tom, thinking back to the Woodward Investor Day in December back in New York and the cumulative 5-year free cash flow target, $2 billion, $400 million this year. And I think myself and others probably thought the -- that doesn't imply any growth on a 5-year time frame to get to $2 billion. That was too conservative. Now assuming the deal closes, and I'm going to pick September 15. So say, 8 months from now, the third calendar quarter this year, we're going to go from a consensus number of like around $750 million up to $1 billion. And that's in the first year of closing, which is going to start so quickly. And so if I'm thinking about that number, it seems like the only way to achieve such a 33% increase in the consensus free cash flows, either those numbers that each company provided relatively recently were just far too low or you're able to target a synergy that's going to fall right into your lap as soon as the deal closes. Just want to get my head around that.

Well, a little bit on, George, there's consensus and there's our actual forecast, and they're not the same. And I guess, what we're highlighting today is we're driving higher free cash flow, and I think our analysts are anticipating. And as we highlighted, it's going to be earnings growth, working capital improvement and lower CapEx. And that combination, we think we're going to be approximately $1 billion combined free cash flow. The other element of free cash flow, I'd like to not -- you guys haven't really asked or have delve in into is the consistent cash flow over market cycle. I think this is really a real attribute of our merger. And that when you look -- I'd just say, take a single aircraft program and look at the start of the program, the investment to the end of the aftermarket. And between us, we're going to have early high margin, good cash flow and consistent through the whole life cycle. And what that really amounts to, if you could talk about is, we have complementary business models. Hexcel makes good high margins as the OEM program is ramping up and stabilizes. Our margins grow with the ramp-up and then excel as the aftermarket comes on. So it's a long, consistent revenue and cash flow cycle. And I think it's incredibly attractive and complementary, and it's supported by industry-leading margins, operational excellence and the ability that we've both proven to deliver great cash flow. So I think that's -- I'd like all of you to hear that, and I think it's something special and unique about this combination.

Your next question comes from the line of Pete Skibitski of Alembic Global.

Tom, to tie this up, tell me if I'm wrong, but my sense, obviously, you went from, Woodward that is, from 2 to 3x the dollar content on the current generation narrow-bodies versus the prior generation. And I imagine you have a goal like that on the next generation of aircraft. And I know, obviously, you've got a long-term tech investment plan, kind of a product plan. Is this a case where you guys looked at that 20-year plan and saw some gaps and really didn't see a better way to fill those gaps than a combination with Hexcel because, obviously, you're on the board, you know their product is pretty cold? Is this kind of generally what happened here?

No. What I'd say is we are highly confident in delivering the organic growth that we've highlighted. What I've seen with this combination is to even accelerate it beyond what we saw that we could do independently. It's not at all a lack of our ability to grow. But this is going to enable us to expand into new areas, leverage sales channels where each other has a better market position that we can pull more through those channels. And then I said, it's -- the 10-year, the 20-year outlook, where we have to think in those time frames to develop the technology to work with our customers to bring it to market. And that's where I see enhanced growth coming. So this is not at all a concern about our current R&D portfolio or our growth rates.

Okay. So you would have been fine, but this is kind of 1 plus 1 equals 3 on that long-term plan?

Exactly.

Thank you. That does conclude today's conference call. You may now disconnect.