Hexcel Corporation — Q2 2015 Form 10-Q
Business context and period. Hexcel develops and manufactures advanced composite materials and structures for commercial aerospace, space and defense, and industrial markets. This unaudited report covers the quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $475.7 million | $470.1 million | $947.5 million | $931.8 million |
| Gross margin | $139.1 million; 29.2% | $129.1 million; 27.5% | $280.9 million; 29.6% | $258.3 million; 27.7% |
| Operating income | $90.6 million | $75.1 million | $173.2 million | $149.7 million |
| Net income | $61.7 million | $50.6 million | $129.8 million | $100.7 million |
| Diluted EPS | $0.63 | $0.51 | $1.32 | $1.01 |
| Operating cash flow | — | $50.2 million | $110.3 million |
- Q2 sales rose 1.2% reported, or 5.4% in constant currency; first-half sales rose 1.7% reported, or 5.8% in constant currency. Commercial aerospace led growth.
- Q2 operating income increased 20.6%; first-half operating income increased 15.7%. The 2014 comparison included a $6.0 million environmental-reserve charge. Excluding that item, adjusted operating income increased 11.7% for Q2 and 11.2% for the first half.
- Q2 gross margin improved 1.7 percentage points year over year. Management attributed the strong performance to operating results and noted favorable foreign-exchange impacts of about 90 basis points in Q2 and 80 basis points for the first half.
- First-half 2015 net income included an $11.6 million tax benefit, primarily from releasing uncertain-tax-position reserves. Excluding this discrete benefit, adjusted net income was $118.2 million versus $104.6 million in 2014.
- First-half free cash flow, defined by Hexcel as operating cash flow less capital expenditures, was negative $116.1 million versus negative $8.9 million. Cash capital expenditures were $166.3 million versus $119.2 million. Management cited working-capital use, including a strategic inventory build, and increased investment.
Balance sheet, liquidity and debt
- At June 30, 2015, cash was $35.3 million, total debt was $508.0 million, and debt net of cash was $472.7 million. Net debt was $345.4 million at December 31, 2014.
- Hexcel had $189.9 million of undrawn availability under its $700 million revolving credit facility, after $2.1 million of letters of credit. The facility matures in 2019; the company reported no significant required debt repayments before then.
- The facility requires minimum interest coverage and maximum leverage ratios of 3.50. Hexcel reported compliance with all debt covenants at quarter-end and expected to remain in compliance.
- Management expected short-term liquidity needs, including capital expenditures, to be met with operating cash flow, cash on hand, and the credit facility.
Business changes and management outlook
- Commercial aerospace sales rose 5.4% in Q2 and 5.5% in the first half. Combined revenue from the B787, A350 XWB, A320neo, and B737 MAX programs increased more than 30% in Q2, led by A350 XWB shipments. Legacy Airbus and Boeing aircraft sales were a few percentage points lower.
- Space and defense sales declined 4.5% in Q2 and 5.8% for the first half. Growth in Hexcel’s largest programs partly offset programs winding down or reducing build rates; commercial helicopter sales were about 20% lower year over year in Q2.
- Industrial sales declined 9.7% in Q2 and 5.4% for the first half on a reported basis. Management said first-half industrial sales were 6.0% higher in constant currency, with wind-energy sales up nearly 10% on that basis.
- Management forecast 2015 accrual-basis capital expenditures of $260 million to $290 million, primarily for capacity expansion to support customer demand, including the A350 ramp-up. The filing provides no specific full-year revenue or earnings guidance.
Risks, contingencies and unusual items
- Environmental accruals totaled $3.6 million at June 30. For certain sites, accruals were at the low end of estimated ranges; where Hexcel could estimate exposure, accruals would have been $28 million higher at the high end. The company noted uncertainty over remediation scope and its share of costs.
- For the Lower Passaic River, the EPA’s proposed alternatives included remediation estimated at $0.8 billion to $3.25 billion for the lower eight miles. Hexcel had not determined its allocable share; its recorded accrual was $2.0 million.
- Hexcel recorded a $22.0 million liability for unpaid European VAT and a corresponding customer receivable, plus $1.2 million of interest. It expected to recover VAT from customers but could not determine whether additional charges would arise; payment and reimbursement timing may differ.
- Foreign-currency movements affected reported results and derivatives. Hexcel expected to reclassify $10.5 million of unrealized hedge losses into earnings over the next 12 months as hedged sales are recorded. Disclosed risks also include aircraft production rates and program ramps, customer concentration, defense-program changes, raw-material supply and prices, capacity execution, currency and interest rates, and environmental matters.
Important facts for investors to verify
- Whether commercial-aircraft program ramps, particularly the A350, support the projected demand and planned capacity investments.
- Whether working capital and capital-spending levels moderate as expected, and how they affect cash flow, debt, and facility headroom.
- The full-year tax rate excluding the $11.6 million discrete benefit and the sustainability of reported earnings growth.
- Developments in the Lower Passaic River remediation, other environmental claims, and the European VAT recovery and potential additional charges.
- Compliance with credit-facility covenants as borrowing and investment needs evolve.