Hexcel Corporation — Q1 2020 Form 10-Q
Business context and period. Unaudited results for the three months ended March 31, 2020, compared with Q1 2019. Hexcel develops and manufactures advanced composite materials and engineered products, primarily for commercial aerospace, space and defense, and industrial markets.
Key financial results
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $541.0 million | $609.9 million | Down 11.3% (11.0% constant currency) |
| Gross margin | $140.9 million; 26.0% | $167.2 million; 27.4% | Margin down 1.4 percentage points |
| Operating income | $65.7 million; 12.1% margin | $102.8 million; 16.9% margin | Down 36.1% |
| Net income | $42.4 million | $72.2 million | Down 41.3% |
| Diluted EPS | $0.50 | $0.84 | Down 40.1% |
| Operating cash flow | $8.6 million | $45.9 million | Down $37.3 million |
| Capital expenditures | $27.2 million | $61.1 million | Down $33.9 million |
| Free cash flow (non-GAAP) | $(18.6) million | $(15.2) million | Greater cash use |
At March 31, cash and equivalents were $329.3 million, versus $64.4 million at year-end 2019. Total debt was $1,390.1 million, versus $1,060.1 million; net debt was $1,060.8 million, versus $995.7 million at year-end. The company had $693 million drawn on its $1 billion revolving facility and $307 million undrawn. It said the additional $250 million draw during the quarter was a precautionary response to the pandemic. Facility covenants require minimum interest coverage of 3.50 and maximum leverage of 3.75, with a specified acquisition-related step-up to 4.25.
Working capital used $94.8 million of cash, compared with $78.4 million in Q1 2019. The company attributed lower operating cash flow to lower earnings and higher working capital. The next significant scheduled debt maturity is in 2024, when the revolving facility expires.
Material changes and drivers
- Commercial Aerospace revenue fell 12.7% to $362.9 million, principally due to lower Boeing 737 MAX sales and the end of the A380 program; higher 787 and 777X sales partly offset the decline.
- Space & Defense revenue rose 3.5% to $111.6 million, supported by rotorcraft, including Black Hawk, and space programs.
- Industrial revenue fell 23.2% to $66.5 million, with wind-energy sales affected by temporary COVID-related plant closures in China and Austria.
- Composite Materials revenue declined 10.1% to $438.5 million; Engineered Products revenue declined 16.1% to $102.5 million. Segment operating income was $91.5 million and $6.5 million, respectively, compared with $112.5 million and $14.8 million.
- Operating income included $14.7 million of merger-related costs, primarily professional fees. Excluding this item, adjusted operating income was $80.4 million and adjusted diluted EPS was $0.64; both are non-GAAP measures.
- Q1 2020 comprehensive income was $5.8 million, versus $66.3 million, reflecting $36.6 million of other comprehensive loss, including currency translation and derivative losses.
Outlook, commentary, risks and contingencies
- Management said COVID-19 had begun to reduce air traffic and customer demand and disrupt customer and supplier facilities. Hexcel expected continued adverse effects on results, cash flows, and financial position, but said the financial impact could not be reasonably estimated. It provided no specific revenue or earnings guidance in this filing; its estimated underlying full-year effective tax rate was 23%.
- Cost actions announced after quarter-end included temporary salary reductions and unpaid furloughs, executive and director fee reductions, suspension of the 401(k) match and employee stock purchase plan, and suspension of dividends and share repurchases. Hexcel targeted a rolling 30% labor-cost reduction beginning in Q2, but had not yet estimated related restructuring costs and could take further actions.
- On April 5, 2020, Hexcel and Woodward terminated their planned all-stock merger, citing the pandemic’s impact. Q1 included related costs. On April 6, Hexcel adopted a shareholder rights plan, generally triggered by an unapproved acquisition of 15% or more of common stock; it was set to expire April 6, 2021.
- Management said the company continued operating across its footprint, including critical defense programs, while warning of possible facility closures, workforce and supply-chain disruption, lower aerospace demand, customer or supplier financial distress, and pressure on margins and liquidity. Commercial Aerospace represented approximately 68% of 2019 sales.
- Environmental accruals totaled $2.7 million. For sites where liability could be estimated, accrual at the high end of the range would have been approximately $16 million greater. The company cited uncertainty in allocation and remediation costs, including the Lower Passaic River matter. Management did not expect currently pending legal proceedings to materially affect results, financial position, or cash flows.
- COVID-19 triggered a goodwill impairment review; management concluded impairment was not more likely than not at March 31. Foreign-currency and commodity hedges carried material fair-value liabilities, including $24.9 million for foreign-exchange contracts and $8.9 million for commodity swaps.
Important facts for investors to verify
- How quickly commercial aircraft production and air travel recover, especially Boeing and Airbus demand, and the resulting effect on Hexcel’s sales, margins, and cash generation.
- Whether planned cost reductions are implemented as described, their restructuring costs, and any further dividend or repurchase policy changes.
- Liquidity, working-capital trends, revolver borrowings, and covenant headroom if operating cash flow weakens further.
- Progress and eventual allocation of environmental remediation liabilities, particularly the Lower Passaic River exposure.
- Whether derivative losses, currency movements, and commodity prices create further earnings or balance-sheet volatility.
- Impact of the Woodward merger termination costs and the shareholder rights plan on future corporate developments.