Hexcel Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Hexcel develops and manufactures lightweight composite materials and engineered products for commercial aerospace, space and defense, and industrial markets. Amounts below are in millions of dollars except per-share data.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $448.8 | $451.9 | $1,396.3 | $1,383.7 |
| Gross margin | $124.1; 27.7% | $122.0; 27.0% | $405.0; 29.0% | $380.3; 27.5% |
| Operating income | $78.0 | $79.0 | $251.2 | $228.7 |
| Net income | $53.5 | $55.8 | $183.3 | $156.5 |
| Diluted EPS | $0.55 | $0.57 | $1.88 | $1.58 |
| Operating cash flow | Not provided quarterly | Not provided quarterly | $164.3 | $191.8* |
| Capital expenditures, cash basis | Not provided quarterly | Not provided quarterly | $249.3 | $194.4 |
Q3 sales declined 0.7% reported but rose 2.1% in constant currency. Nine-month sales rose 0.9% reported and 4.6% in constant currency. Nine-month operating income increased 9.8%; the 2014 comparison included a $6.0 environmental charge, and adjusted operating income grew 7.0%. Nine-month reported net income included an $11.6 tax benefit from releases of uncertain-tax-position reserves; adjusted net income was $171.7 versus $160.7 in 2014.
Q3 interest expense was $4.6 versus $2.1; nine-month expense was $9.0 versus $5.9, reflecting higher debt and the 2025 notes. SG&A rose 7.9% in Q3 and 8.4% year to date, partly from ERP and other systems work. Management attributed improved gross margin to strong operations and favorable currency effects of about 50 basis points in Q3 and 70 basis points year to date.
Markets and segments
- Commercial aerospace: Q3 sales increased 6.1% to $314.5; nine-month sales increased 5.7% to $959.5. New aircraft programs (B787, A350 XWB, A320neo and B737 MAX) grew more than 50% in Q3, led by A350 shipments; legacy Airbus and Boeing aircraft sales were about 8% lower.
- Space and defense: Q3 sales declined 12.7% to $77.3; nine-month sales declined 8.0% to $254.2. Management cited the expected C-17 program end, lower helicopter sales and less predictable smaller-program orders.
- Industrial: Q3 sales declined 14.8% to $57.0; nine-month sales declined 8.5% to $182.6, although nine-month sales were up 1.8% in constant currency.
- Segment performance: Nine-month Composite Materials sales rose 2.6% and operating income rose to $254.5 from $230.1. Engineered Products sales fell 4.6% and operating income fell to $43.3 from $50.7.
Cash, debt and liquidity
- Cash was $43.2 at September 30, down from $70.9 at year-end 2014. Total debt was $596.4; net debt was $553.2, compared with $345.4 at year-end.
- Nine-month free cash flow, defined as operating cash flow less cash capital expenditures, was a use of $85.0 versus a use of $2.6 in 2014. Working capital used $117, principally from payment timing and strategic inventory and ERP-related safety-stock build-up.
- Accrual-basis capital additions were $227.8 year to date. Management expected full-year 2015 capital expenditures to be at the high end of its $260–$290 range, mainly for capacity expansion including A350-related needs.
- In August, Hexcel issued $300 of 4.7% senior notes due 2025; proceeds were initially used partly to repay its revolving credit facility. Facility borrowings were $300 under a $700 facility, with $397.9 undrawn availability after letters of credit. The company reported covenant compliance and no significant required debt repayments before the facility’s 2019 maturity.
- Debt covenants require minimum interest coverage of 3.50 and maximum leverage of 3.50. Management expected to meet short-term liquidity needs through operating cash flow, cash and the facility.
Outlook, risks and unusual items
- Management highlighted continued growth from new commercial aircraft programs and ongoing capacity investment, but did not provide a specific sales or earnings forecast in the supplied filing text.
- In October 2015, after quarter-end, the board authorized an additional $250 stock repurchase plan. In Q3, the company repurchased about 2.0 million shares for $100, completing the prior authorization, and paid $28.9 in dividends during the first nine months.
- A European VAT matter resulted in a $22.0 liability and a corresponding customer receivable, plus $1.3 of interest payable. Hexcel expected to settle outstanding amounts in Q4 but could not rule out additional charges.
- Environmental reserves totaled $3.0 at September 30. For estimable matters other than Lodi, reserves were generally at the low end of possible ranges; recording at the high end would have increased reserves by $28. The Lower Passaic River remediation remains uncertain; EPA alternatives for the lower eight miles were estimated at $0.8–$3.25 billion, but Hexcel’s eventual allocation was undetermined.
- Other key risks identified include aircraft delivery-rate changes or program delays, customer concentration, defense-budget and program changes, currency and commodity fluctuations, limited-source raw materials, manufacturing capacity constraints, ERP/network disruption, environmental obligations and execution of capacity additions.
- Foreign-exchange hedges generated losses recognized in gross margin of $4.2 in Q3 and $13.0 year to date. Hexcel expected to reclassify $9.0 of unrealized hedge losses into earnings over the next 12 months as hedged sales occur.
Most important facts to verify
- Cash-flow comparison: The cash-flow statement reports 2014 nine-month operating cash flow of $191.8, while MD&A states $198.1 in one passage and $191.8 elsewhere. Verify the correct comparative amount.
- Track working-capital recovery, inventory levels and free cash flow as elevated capital spending and strategic inventory build weigh on cash.
- Assess whether commercial-aerospace program growth offsets declines in space and defense and industrial markets, and whether capacity additions support margins.
- Monitor the VAT settlement, any additional related charges, and developments in environmental matters, particularly Lower Passaic allocation and reserve estimates.
- Confirm debt-covenant headroom and the funding implications of the new $250 repurchase authorization, dividends and capital-expenditure plan.
*The filing’s cash-flow statement gives $191.8 for 2014 operating cash flow; the MD&A contains the inconsistent $198.1 figure noted above.