Hexcel Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited consolidated financial statements; amounts in U.S. dollars unless noted.
Business context
Hexcel develops and manufactures lightweight composite materials and engineered products for commercial aerospace, space and defense, and industrial markets. Its operating segments are Composite Materials and Engineered Products.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $540.5 million | $491.5 million | $1,628.1 million | $1,461.6 million |
| Gross margin | $143.0 million; 26.5% | $135.6 million; 27.6% | $430.4 million; 26.4% | $409.6 million; 28.0% |
| Operating income | $96.5 million; 17.9% of sales | $89.1 million; 18.1% | $275.4 million; 16.9% | $257.4 million; 17.6% |
| Net income | $80.1 million | $69.7 million | $210.5 million | $195.9 million |
| Diluted EPS | $0.91 | $0.76 | $2.35 | $2.13 |
| Operating cash flow | Not separately reported for quarter | Not separately reported for quarter | $278.4 million | $308.5 million |
| Capital expenditures | Not separately reported for quarter | Not separately reported for quarter | $150.2 million | $221.3 million |
| Free cash flow (non-GAAP) | Not separately reported for quarter | Not separately reported for quarter | $128.2 million | $87.2 million |
Quarterly sales rose 10.0% year over year (10.4% in constant currency); nine-month sales increased 11.4% (10.3% in constant currency). Q3 net income increased 14.9% and diluted EPS 19.7%. For the first nine months, net income increased 7.5% and diluted EPS 10.3%. The filing also reports non-GAAP adjusted diluted EPS of $0.80 for Q3 and $2.23 year to date, versus $0.71 and $1.98, respectively, in 2017.
Sales grew across all end markets. Q3 Commercial Aerospace sales increased 5.8%, Space & Defense 9.3%, and Industrial 37.0%. Industrial growth was led by wind energy; aerospace gains reflected higher production rates, new narrow-body aircraft content, and stronger business-jet demand. Segment operating income was $92.5 million for Composite Materials and $15.5 million for Engineered Products in Q3.
Cash, debt and liquidity
- Cash and cash equivalents were $47.2 million at September 30, 2018, versus $60.1 million at year-end 2017. Total debt was $990.0 million, up from $809.9 million; net debt was $942.8 million, versus $749.8 million.
- Cash from operations was lower year over year, partly reflecting a $64.6 million working-capital cash use, compared with a $4.6 million source in the 2017 period. Free cash flow increased because capital expenditures were lower.
- The company returned $318.3 million to shareholders in the first nine months through $282.8 million of share repurchases and $35.5 million of dividends. It had $459.7 million remaining under its $500 million repurchase authorization at September 30.
- Borrowings under the $700 million revolving credit facility were $235.0 million, with $465.0 million undrawn availability. The company reported compliance with debt covenants and said it expected to remain in compliance. The facility matures in 2021; the filing identifies no significant required debt repayments before then.
Changes, outlook and risks
- Gross and operating margins declined year over year despite higher sales. Management cited acrylonitrile costs associated with higher oil prices, wind-energy resin costs related to pollution-control measures in China, tariffs, higher depreciation and amortization, and startup costs at a new French site. Research and technology spending increased as the company continued investing in composite technology; SG&A was lower in constant currency.
- Management expected 2018 accrual-basis capital expenditures of $170 million to $190 million. It stated short-term liquidity needs, including capital expenditures, were expected to be met with operating cash flow, cash on hand, and the revolving facility. The filing does not provide a quantified sales or earnings forecast.
- Quarterly effective tax rate was 9.1%, including $9.6 million of discrete tax benefits. The nine-month rate was 16.9%; excluding discrete benefits, the filing gives rates of 21.3% for 2018 and 24.2% for 2017. These benefits boosted reported earnings and are not necessarily recurring.
- Hexcel adopted ASC 606 revenue recognition in 2018. Management said its impact on reported revenue and gross margin was not material to earnings per share. At September 30, contract assets were $43.7 million; inventory was $38.4 million lower than it would have been without adoption.
- Environmental contingencies include the Lower Passaic River matter. Aggregate environmental accruals were $2.8 million; for certain sites, accruals were at the low end of a range, and the filing says the total could have been $16 million higher at the high end. The company noted substantial uncertainty about its eventual share of remediation costs and insurance recovery.
- The company added a risk disclosure concerning tariffs: trade-policy changes could raise input costs and prompt retaliatory tariffs affecting the competitiveness of U.S.-made products. Other cited risks include customer and aircraft-production changes, raw-material availability and cost, capacity execution, currency movements, and legal or environmental outcomes.
Important facts for investors to verify
- Whether sales growth, particularly in industrial wind energy and aerospace programs, is sustained and translates into improved margins.
- How input-cost inflation, tariffs, French-site startup costs, and higher depreciation affect gross margin and operating income.
- Working-capital trends, capital spending against the $170 million–$190 million expectation, and the company’s ability to generate cash while funding repurchases and dividends.
- Debt levels, interest expense, revolving-facility availability, and continued covenant compliance.
- The eventual scope, allocation, and cost of environmental remediation, especially the Lower Passaic River matter, and the adequacy of related reserves and insurance.
- The size and timing of discrete tax benefits and the final tax adjustments relating to the Tax Cuts and Jobs Act.