Hexcel Corporation — Q2 2017 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and six months ended June 30, 2017, compared with the corresponding 2016 periods. Hexcel manufactures composite materials and engineered products for commercial aerospace, space and defense, and industrial markets.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $491.3m | $522.6m | $970.1m | $1,020.3m |
| Gross margin | $139.9m; 28.5% | $150.3m; 28.8% | $274.0m; 28.2% | $293.3m; 28.7% |
| Operating income | $89.7m; 18.3% of sales | $100.1m; 19.2% | $168.3m; 17.3% | $184.0m; 18.0% |
| Net income | $61.6m | $66.1m | $126.2m | $122.1m |
| Diluted EPS | $0.67 | $0.70 | $1.37 | $1.29 |
- Quarterly sales declined 6.0% (5.4% in constant currency); first-half sales declined 4.9% (4.0% in constant currency). Quarterly operating income fell 10.4%; first-half operating income fell 8.5%.
- First-half GAAP net income and EPS increased, but benefited from a $9.1m discrete tax benefit from releasing a foreign-jurisdiction valuation allowance. Excluding that benefit, adjusted net income was $117.1m versus $122.4m in 2016, and adjusted diluted EPS was $1.27 versus $1.29.
- Q2 sales by market: commercial aerospace $349.0m, down 5.3%; space and defense $87.8m, up 7.3%; industrial $54.5m, down 24.6%. Industrial weakness included wind-energy sales down more than 30%.
- First-half operating cash flow was $182.4m versus $134.9m. Capital expenditures were $169.2m versus $156.0m; free cash flow, as defined by the company, was $13.2m versus a $21.1m use.
- At June 30, cash was $45.5m, total debt was $821.6m, and debt net of cash was $776.2m. The $700m revolving facility had $65m drawn and $635m available. The company reported compliance with debt covenants.
- Total assets were $2,627.3m and stockholders’ equity was $1,330.3m. Inventories were $313.0m, up from $291.0m at year-end 2016.
Material changes and management commentary
- Commercial aerospace declines in legacy widebody programs (A380, B777 and B747), customer inventory adjustments, and weaker regional and business aircraft sales outweighed growth in the A350 and new narrowbodies. Hexcel revised estimated A350 content per shipset to approximately $4.8m from $5.0m, citing customer productivity initiatives that reduce scrap and material usage.
- Space and defense grew, with rotorcraft sales at their highest level in two years. Engineered Products’ Q2 operating income rose to $12.1m from $11.7m despite lower sales; Composite Materials operating income declined to $92.1m from $101.6m.
- First-half gross margin included approximately $5m of startup and training costs for new facilities in France and Morocco. Management cited strong underlying operating performance and tight SG&A cost control; research and technology spending increased to support product development.
- In February, Hexcel issued $400m of 3.95% senior notes due 2027 and entered into a €35m additional tranche of its Euro term loan. Proceeds from the notes were used partly to repay revolving borrowings, with remaining funds available for general purposes, including share repurchases. First-half share repurchases totaled $120.8m; $271.9m remained under the 2017 authorization at quarter-end.
Outlook, risks and contingencies
- The filing gives no overall revenue or earnings guidance. Management expected 2017 accrual-basis capital expenditures of $270m–$290m to expand capacity, and expects second-half free cash flow to be a significant source relative to the first half, reflecting normal seasonality.
- Management expects 2018 wind-energy sales to exceed 2016 levels as customers transition to longer, higher-efficiency blades with greater composite content. This is an expectation, not a guarantee; 2017 wind sales were materially weaker.
- Key disclosed uncertainties include aircraft production rates and program ramps, customer inventory and delivery changes, dependence on major customers and limited raw-material sources, industrial and defense demand, capacity execution, foreign exchange and interest rates, and legal and environmental matters.
- Environmental accruals totaled $2.9m. The company’s Lower Passaic River reserve was $2.1m; the EPA’s estimated remedy cost for the lower eight miles was $0.97bn–$2.07bn, and Hexcel had not determined its allocable share. For certain sites, accruing at the high end of estimable ranges would have increased reserves by $16m. Management said ultimate obligations remain uncertain.
- The first-half effective tax rate was 19.8%, including the $9.1m discrete benefit; excluding it, the rate was 25.7%. Q2’s 26.7% rate also benefited from state tax adjustments and share-based compensation deductions.
- Hexcel was evaluating the effects of the new revenue-recognition standard, planned for adoption January 1, 2018; some contracts with customer termination-for-convenience clauses may be affected. The company was also assessing the impact of the lease standard planned for adoption in 2019.
Important facts for investors to verify
- Whether aircraft build rates, legacy widebody reductions, and A350 and narrowbody growth develop as management anticipated.
- Whether industrial and wind-energy demand recovers on the stated timetable, and whether 2017 capital spending converts into productive capacity and returns.
- Underlying earnings trends after separating the $9.1m tax benefit, startup costs, and foreign-exchange effects.
- Debt, covenant headroom, buyback pace, and liquidity as capital expenditures and shareholder returns continue.
- Potential changes to environmental liabilities, particularly Hexcel’s eventual share of the Lower Passaic River remediation, and the financial effect of revenue-standard adoption.