Hexcel Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Hexcel develops and manufactures composite materials and engineered products for commercial aerospace, space and defense, and industrial markets. Figures are in U.S. dollars; financial statement amounts are in millions except per-share data.
Financial highlights
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $522.6 | $475.7 | $1,020.3 | $947.5 |
| Gross margin | $150.3; 28.8% | $139.1; 29.2% | $293.3; 28.7% | $280.9; 29.6% |
| Operating income / margin | $100.1 / 19.2% | $90.6 / 19.0% | $184.0 / 18.0% | $173.2 / 18.3% |
| Net income | $66.1 | $61.7 | $122.1 | $129.8 |
| Diluted EPS | $0.70 | $0.63 | $1.29 | $1.32 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $134.9 | $50.2 |
| Capital expenditures, cash basis | Not provided for quarter | Not provided for quarter | $156.0 | $166.3 |
| Free cash flow | Not provided for quarter | Not provided for quarter | $(21.1) | $(116.1) |
At June 30, cash was $38.9, total debt $707.6, and net debt approximately $669. Current assets were $684.6 and current liabilities $271.6. The $700 million revolving facility had $410 million drawn and $287.9 million undrawn availability after letters of credit. The company reported compliance with debt covenants. Long-term debt was $706.8; the principal facility maturity was extended to June 2021, and the company reported no significant required debt repayments before then.
Changes and operating trends
- Q2 sales rose 9.9% year over year (10.2% in constant currency); first-half sales increased 7.7%. Q2 net income and diluted EPS rose 7.1% and 11.1%, respectively. First-half net income and diluted EPS fell 5.9% and 2.3%.
- Commercial aerospace led growth: Q2 sales increased 13.5%, with new aircraft programs (B787, A350 XWB, A320neo and B737 MAX) up more than 50%; A350 XWB shipments led. Space and defense sales declined 7.0%, primarily reflecting rotorcraft weakness. Industrial sales grew 14.8%, including contributions from Formax.
- Q2 gross margin declined 0.4 percentage points year over year; first-half gross margin fell 0.9 points. Management attributed first-half pressure to start-up of production lines for additional capacity. Q2 operating margin edged up, while first-half operating margin declined.
- Engineered Products operating margin decreased to 12.0% from 14.1% in Q2. Management cited increased competition and new-program learning curves, and expected volatility as mature programs wind down and new programs ramp.
- First-half operating cash flow improved by $84.7, with working-capital use of $72 versus $135 in the prior-year period, primarily due to timing. Capital spending remained substantial. Interest expense increased to $11.3 for the half from $4.4, reflecting higher debt and the 2015 issuance of $300 million of 4.7% notes.
Outlook, transactions and notable items
- Management forecast 2016 accrual-basis capital expenditures of $280–$320 million to expand capacity. It expected working capital to be a modest source of cash in the second half and anticipated meeting near-term liquidity needs through operating cash flow, cash on hand and the revolving facility. No specific full-year sales or earnings guidance is stated in the filing text.
- Hexcel amended and extended its $700 million credit facility to June 2021, with reduced borrowing costs and less restrictive covenants. It also entered into a €60 million term-loan arrangement; no amount was outstanding at quarter-end.
- In January, Hexcel acquired the remaining 50% of Formax for $12 million, completing its acquisition of the company. In Q2 it invested $15 million for a 10.3% interest in Oxford Performance Materials, with a potential additional $10 million investment subject to milestones or Hexcel’s discretion. It also issued Luminati Aerospace a $10 million, 8% convertible secured note.
- The company repurchased $54.9 million of stock during the first half under its $250 million authorization; approximately $149 million remained. First-half dividends were $19.6 million.
- Environmental accruals totaled $3.5 million. For certain sites, estimated liability was accrued at the low end of a range; the aggregate accrual could have been $16 million higher if estimated at the high end. For the Lower Passaic River, EPA’s selected remedy was estimated to cost $0.97–$2.07 billion across the site; Hexcel had not determined its allocable share, and its accrual was $2.2 million. Management said known contingencies were not expected to have a material adverse effect, while noting estimates may change.
- First-half 2016 tax expense included a $1.2 million benefit from early adoption of share-based-payment accounting guidance; excluding it, the effective tax rate was 30.5%. The comparable 2015 period included $11.6 million of tax benefits, primarily from releasing uncertain-tax-position reserves; excluding those benefits, the 2015 rate was 30.6%.
- Key stated risks include aircraft production rates and program ramp-ups, customer concentration, defense-budget and rotorcraft demand, competition, capacity execution, foreign-exchange and interest-rate movements, supply constraints, environmental obligations, and uncertainty around the U.K.’s potential exit from the EU. Management reported effective disclosure controls and no material change in internal control over financial reporting during Q2.
Important facts for investors to verify
- Whether growth in new commercial-aircraft programs and planned capacity expansion translate into sustained sales and margins, particularly given start-up costs and program timing.
- Whether the decline in Space & Defense and Engineered Products profitability persists, and how competitive and program-transition pressures develop.
- Whether working-capital timing supports the expected second-half cash generation while planned capital expenditures remain elevated.
- Debt levels, borrowing costs, facility covenant headroom, and cash returned through repurchases and dividends.
- Developments in the Lower Passaic River and other environmental matters, including Hexcel’s eventual share of remediation costs versus current accruals.
- The effect of the 2015 discrete tax benefit on year-over-year comparisons and the performance of the new affiliate investments.