Business Context and Reporting Period
Company: Hexcel Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 1998
Business Overview: Hexcel is a global, vertically integrated advanced materials company serving commercial aerospace, space and defense, electronics, and industrial markets. The quarter was defined by the strategic acquisition of the industrial fabrics business from Clark-Schwebel, Inc. (the "Acquired Fabrics Business") on September 15, 1998, diversifying the company beyond its traditional aerospace focus.
Key Financial Metrics
| Metric (in thousands) | Q3 1998 | Q3 1997 | YTD 1998 | YTD 1997 |
|---|---|---|---|---|
| Net Sales | $255,303 | $226,611 | $785,581 | $682,249 |
| Gross Margin | $61,847 (24.2%) | $54,967 (24.3%) | $199,164 (25.4%) | $159,672 (23.4%) |
| Operating Income | $27,563 | $9,331 | $99,455 | $50,229 |
| Net Income | $11,498 | $37,948 | $48,546 | $61,307 |
| Diluted EPS | $0.29 | $0.87 | $1.15 | $1.48 |
| Adjusted Diluted EPS | $0.32 | $0.26 | $1.18 | $0.81 |
| Adjusted EBITDA | $39,400 | $34,400 | $131,100 | $99,400 |
| Cash from Operations (YTD) | $48,086 | ($19,059) | ||
| Free Cash Flow Target | ||||
| Total Debt (Long-term + Current) | $821,380 (as of 9/30/98) | |||
| Cash and Equivalents | $3,870 (as of 9/30/98) |
Note: Adjusted metrics exclude business acquisition/consolidation expenses and non-recurring tax items. YTD 1997 operating cash flow was negative due to working capital increases and restructuring payments.
Material Changes vs. Prior Period
- Revenue Growth: Q3 1998 sales increased 13% to $255.3 million, driven by strong commercial aerospace demand and the inclusion of the Acquired Fabrics Business (approx. $7.0 million in sales for the two-week post-acquisition period). Excluding the acquisition, organic sales grew 10%.
- Profitability: Operating income surged to $27.6 million (10.8% margin) from $9.3 million (4.1% margin) in Q3 1997. This improvement is largely due to a $14.7 million reduction in business acquisition and consolidation expenses compared to the prior year.
- Net Income Volatility: Reported net income decreased significantly to $11.5 million from $37.9 million in Q3 1997. The 1997 figure was artificially inflated by a one-time $39.0 million tax benefit from the reversal of a U.S. tax valuation allowance. On an adjusted basis, earnings per share increased 23%.
- Debt Structure: Total debt increased substantially to fund the $453 million acquisition of the Fabrics Business. Hexcel secured a new $910 million Senior Credit Facility, with $611.9 million drawn as of September 30, 1998.
- Backlog: Aerospace backlog decreased 19% to $384.9 million from year-end 1997, reflecting industry trends toward shorter lead times and better supply chain management.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Market Conditions: Management notes increased volatility and pricing pressures. Carbon fiber orders for Q4 were cancelled due to customer inventory corrections following 1997 shortages. Pricing in the fabrics business faces pressure from Asian and Eastern European competition.
- Strategic Initiatives: Hexcel is intensifying "Lean Enterprise" and business consolidation programs to reduce costs. A reorganization is underway to integrate the Acquired Fabrics Business and consolidate composite materials into a single global unit.
- Cash Flow Goal: The company targets generating $100 million in free cash flow over the 15-month period ending December 1999 to repay debt and fund the pending acquisition of CS-Interglas equity interests.
- Future Growth: Despite near-term headwinds, management anticipates growth in carbon fiber sales in 2000+ due to new military aircraft programs and sustained commercial aircraft demand (Boeing/Airbus).
Risks and Contingencies
- Regulatory Approval: The acquisition of a 43.6% interest in CS-Interglas is contingent on German regulatory approval by January 24, 1999. Failure to obtain approval may terminate the obligation to pay the remaining $19 million purchase price.
- Year 2000 Compliance: The company is addressing Year 2000 issues across its supply chain and IT systems. While currently believed manageable, failure to remediate could materially impact operations.
- Customer Concentration: Approximately 46% of 1997 sales were to Boeing, Airbus, and related subcontractors. Loss of these customers or changes in their production rates pose significant risk.
Investor Verification Checklist
- Acquisition Integration: Verify the timeline and cost estimates for integrating the Acquired Fabrics Business, as integration costs are expected to be finalized in Q4 1998.
- Carbon Fiber Demand: Monitor Q4 and 1999 carbon fiber order books to confirm the extent of the inventory correction and pricing pressure mentioned by management.
- Debt Covenants: Review the financial covenants of the new $910 million Senior Credit Facility, particularly restrictions on dividends and capital stock redemption.
- CS-Interglas Status: Track the status of German regulatory approval for the CS-Interglas joint venture interest, which impacts future capital expenditures.
- Year 2000 Costs: Assess the final remediation costs for Year 2000 compliance, as the company currently states total costs are undetermined.