Business Context and Reporting Period
Company: Hexcel Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2007
Business Overview: Hexcel manufactures advanced composite materials and structures. Effective January 1, 2007, the company reorganized its operating segments into three units: Composite Materials, Engineered Products, and EBGI Reinforcements. The company is actively pursuing a portfolio review, having recently sold its European Architectural business and its interest in TechFab, while exploring strategic alternatives for its EBGI Reinforcements segment.
Key Financial Metrics
| Metric (in millions, except per share) | Q1 2007 | Q1 2006 |
|---|---|---|
| Net Sales | $328.7 | $301.2 |
| Gross Margin | $78.3 (23.8%) | $70.0 (23.2%) |
| Operating Income | $33.7 (10.3%) | $29.1 (9.7%) |
| Net Income | $23.5 | $14.5 |
| Diluted EPS | $0.24 | $0.15 |
| Cash and Equivalents | $33.5 | $23.9 |
| Total Debt | $421.6 | $412.3 |
| Net Cash Used in Operating Activities | ($8.9) | ($9.0) |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 9.1% year-over-year, driven by growth in Commercial Aerospace, Space & Defense, and Industrial markets. On a constant currency basis, sales increased 6.2%.
- Profitability: Operating income rose 15.8% to $33.7 million, aided by higher gross margins and a $1.4 million reduction in restructuring expenses compared to the prior year.
- Discontinued Operations: Net income was significantly boosted by a $6.8 million after-tax gain from the sale of the European Architectural business, completed in February 2007.
- Segment Performance:
- Composite Materials: Operating income increased $3.9 million due to higher sales volumes.
- Engineered Products: Operating income decreased $0.6 million due to increased R&T expenses for Boeing 787 certification.
- EBGI Reinforcements: Operating income increased $2.5 million, primarily due to lower restructuring costs and increased ballistics sales.
- Debt Management: The company made mandatory principal prepayments of $35.4 million on its term loan using proceeds from asset sales, resulting in a $0.4 million loss on early retirement of debt.
Guidance, Outlook, and Risks
Management Commentary & Outlook:
- Production: The company expects to reach full-rate production on its new carbon fiber lines by the end of the second quarter of 2007.
- Aerospace: Sales to Airbus A380 were at a two-year low due to program delays, which is expected to impact year-over-year comparisons for much of 2007. However, management expects build rate increases and A350XWB development to mitigate this.
- Strategic Review: The company continues to explore strategic alternatives, including potential divestiture, for the EBGI Reinforcements segment.
- Divestitures: Proceeds from divestitures are being used to prepay debt and fund capital expenditures.
Risks and Contingencies:
- Legal Proceedings:
- Zylon Matter: The DOJ has informed Hexcel it has grounds to file civil claims under the False Claims Act regarding Zylon fiber used in body armor. Hexcel disagrees with the DOJ's views but is cooperating.
- Hercules Indemnity: A court dismissed indemnity counts in a lawsuit filed by Hercules regarding antitrust settlements, though cooperation claims remain.
- Austrian Exotherm: Three employees at the Neumarkt facility were charged with environmental violations following a resin mixing incident; Hexcel is defending the charges.
- Accounting Changes: Adoption of FIN 48 (Accounting for Uncertainty in Income Taxes) on January 1, 2007, increased the liability for unrecognized tax benefits by $0.9 million and is expected to increase volatility in the effective tax rate.
- Liquidity: The company has significant leverage. Future ability to service debt depends on operating performance and market conditions.
Investor Verification Checklist
- Discontinued Operations Impact: Verify the sustainability of earnings by excluding the $6.8 million one-time gain from the sale of the Architectural business.
- Airbus A380 Exposure: Assess the duration and financial impact of the A380 delivery delays on the Commercial Aerospace segment.
- EBGI Divestiture: Monitor progress on the strategic review of the EBGI Reinforcements segment and potential sale terms.
- Legal Liabilities: Track developments in the DOJ Zylon investigation and the Austrian environmental charges for potential accruals.
- Debt Covenants: Confirm compliance with the Senior Secured Credit Facility covenants (minimum interest coverage ratio of 4.00 and maximum leverage ratio of 3.25).
- Carbon Fiber Expansion: Validate the timeline for reaching full-rate production on new carbon fiber lines and associated capital expenditure requirements.