Hexcel Corporation — Q1 2019 Form 10-Q
Business context and period: The filing covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018. Hexcel develops and manufactures advanced composite materials and engineered products for commercial aerospace, space and defense, and industrial markets. Results are unaudited interim results and are not necessarily indicative of full-year performance.
Financial results and position
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| Net sales | $609.9 million | $540.1 million; up 12.9% (14.9% in constant currency) |
| Gross margin | $167.2 million; 27.4% of sales | $142.6 million; 26.4% |
| Operating income and margin | $102.8 million; 16.9% | $82.4 million; 15.3% |
| Net income | $72.2 million | $61.6 million; up 17.2% |
| Diluted EPS | $0.84 | $0.68; up 23.5% |
| Operating cash flow | $45.9 million | $62.6 million |
| Capital expenditures | $61.1 million | $59.5 million |
| Free cash flow (non-GAAP) | Use of $15.2 million | Source of $3.1 million |
| Total debt / cash | $1,169.7 million / $43.7 million | Debt $956.8 million / cash $32.7 million at Dec. 31, 2018 |
At March 31, 2019, net debt was $1,126.0 million, up from $924.1 million at year-end, primarily reflecting the ARC Technologies acquisition. The company had $286 million available under its $700 million revolving facility and reported compliance with debt covenants. Working capital consumed $78.4 million in the quarter, compared with $46.2 million in Q1 2018. Current assets were $782.3 million and current liabilities $349.9 million.
Material changes and business developments
- Hexcel acquired ARC Technologies on January 3, 2019, for approximately $158.4 million in cash, with a further $5.4 million payment due in 2019. The acquisition added $145.8 million of goodwill and intangible assets and contributed to Engineered Products growth.
- Sales increased across all end markets: Commercial Aerospace $415.5 million (+8.6%), Space & Defense $107.8 million (+19.6%), and Industrial $86.6 million (+28.7%). Constant-currency growth was 9.6%, 21.8%, and 36.8%, respectively.
- Management cited strong A320neo and 737 MAX performance, continued 787 and A350 growth, F-35 and military rotorcraft demand, and a 66.6% rise in wind energy sales. ARC acquisition sales contributed to reported growth, particularly in Space & Defense and Engineered Products.
- Interest expense rose 50% to $12.0 million, primarily due to higher debt following the acquisition. The effective tax rate was 22.7%, versus 18.9% a year earlier; management expected the underlying annual rate to remain 24%.
- Operating cash flow declined as working capital needs increased with business growth. Free cash flow turned negative despite higher operating income.
Outlook, risks, and contingencies
- Management expected 2019 accrual-basis capital expenditures of $170 million to $190 million. The filing does not provide a clear full-year revenue or earnings forecast.
- Management said short-term liquidity needs, including capital expenditures, were expected to be funded through operating cash flow, cash on hand, and the revolving facility. The company reported no significant required debt repayments before the facility matures in 2021.
- Key stated risks include changes in aircraft production and deliveries, particularly Airbus and Boeing programs and the 737 MAX; customer concentration; defense budget or program changes; raw-material costs and availability; supply-chain disruptions; capacity installation and qualification; foreign exchange; trade policy and Brexit; and legal or regulatory developments.
- Environmental accruals totaled $2.6 million. The company said the amount could be approximately $16 million higher if certain estimated liabilities were accrued at the high end of possible ranges. Lower Passaic River remediation and allocation remain uncertain; the recorded accrual for that matter was $2.1 million.
- The company disclosed a new risk factor concerning compliance with government procurement, security, and export-control requirements; violations could result in penalties or suspension or debarment from U.S. government contracting.
- Hexcel adopted lease accounting Topic 842 on January 1, 2019, recording approximately $50 million of operating lease right-of-use assets and related liabilities at adoption. At March 31, lease assets were $61.4 million and related liabilities $61.8 million.
Important facts for investors to verify
- How much of sales and earnings growth reflects underlying demand versus ARC acquisition contribution and foreign exchange.
- Whether working-capital investment moderates and operating cash flow improves as sales grow; Q1 free cash flow was negative.
- Integration, expected performance, and cash commitments associated with ARC, including the remaining $5.4 million payment.
- Debt levels, interest costs, covenant headroom, and planned capital spending against the $170 million–$190 million outlook.
- Exposure to aircraft production changes, especially the 737 MAX, and the uncertain ultimate cost of environmental matters.