Hexcel Corporation — Q3 2016 Form 10-Q
Business context and period: Hexcel develops and manufactures advanced composite materials and engineered products for commercial aerospace, space and defense, and industrial markets. This unaudited report covers the quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $500.5 million | $448.8 million | $1,520.8 million | $1,396.3 million |
| Gross margin | $135.7 million; 27.1% | $124.1 million; 27.7% | $429.0 million; 28.2% | $405.0 million; 29.0% |
| Operating income | $89.1 million; 17.8% of sales | $78.0 million; 17.4% | $273.1 million; 18.0% | $251.2 million; 18.0% |
| Net income | $68.2 million | $53.5 million | $190.3 million | $183.3 million |
| Diluted EPS | $0.72 | $0.55 | $2.01 | $1.88 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $286.8 million | $164.3 million |
| Capital expenditures (cash basis) | Not presented quarterly | Not presented quarterly | $231.8 million | $249.3 million |
| Free cash flow (company-defined) | Not presented quarterly | Not presented quarterly | $55.0 million | $(85.0) million |
Changes and operating drivers
- Q3 sales rose 11.5% (11.9% in constant currency); nine-month sales rose 8.9% (9.0% in constant currency). Commercial aerospace was the main growth driver, with Q3 sales up 14.7% and nine-month sales up 12.5% year over year.
- Revenue from new aircraft programs (B787, A350 XWB, A320neo and B737 MAX) increased about 40% in Q3 and just under 50% year to date; A350 XWB shipments led growth. Sales for legacy Airbus and Boeing aircraft were modestly lower.
- Nine-month Space & Defense sales declined 4.6%, driven in part by an approximately 10% decline in rotorcraft. Industrial sales increased 8.9%, with Formax acquisition growth partly offset by weakness in recreation and other industrial markets.
- Gross margin percentage declined year to date, which management attributed to start-up costs for new production lines and capacity expansion. Engineered Products operating margin weakened to 12.6% in Q3 from 14.0%, and to 12.2% year to date from 14.1%; management cited competition, learning curves on new programs, and transitions away from mature programs.
- Q3 net income benefited from a $6.6 million release of uncertain-tax-position reserves. Excluding this discrete tax benefit, adjusted net income was $61.6 million for Q3 and $184.0 million year to date. Nine-month 2015 net income included an $11.6 million tax benefit.
Liquidity, debt and capital allocation
- At September 30, 2016, cash was $45.7 million, total debt was $674.9 million, and net debt was approximately $629 million, compared with $525 million at December 31, 2015. Long-term debt was $670.2 million.
- The amended $700 million revolving credit facility matures in June 2021. Borrowings were $350 million; after $2.1 million of letters of credit, undrawn availability was $347.9 million. Hexcel reported compliance with its debt covenants. A €60 million term loan had $27.4 million outstanding.
- Management said short-term liquidity needs, including capital spending, would be met through operating cash flow, cash on hand and the credit facility. The next significant scheduled debt maturity is the facility in 2021.
- Nine-month capital expenditures were $231.8 million on a cash basis and $232.6 million on an accrual basis. Hexcel spent $84.9 million on share repurchases and $29.7 million on dividends in the period. The 2015 repurchase plan had $119 million remaining at quarter-end.
Outlook, risks and contingencies
- For 2016, management expected free cash flow toward the higher end of its $20–$60 million range and accrual-basis capital expenditures toward the higher end of its $280–$320 million range. Capacity investment was intended to support customer demand, particularly the A350 XWB ramp-up; Hexcel supplies primary-structure prepreg under a contract extending through 2030.
- Management identified risks including aircraft production rates and program delays, customer concentration (including Airbus and Boeing), defense-budget changes, industrial-market weakness, competition, manufacturing constraints, supply disruptions, foreign-exchange and interest-rate changes, and uncertainty regarding the U.K.’s potential exit from the EU.
- Environmental accruals were $3.4 million at September 30, 2016. For certain sites, accruals were recorded at the low end of estimated ranges; the aggregate accrual could have been $16 million higher at the high end. The company’s share of the Lower Passaic River remediation remains uncertain; the EPA’s estimated remedy cost for the lower eight miles was $0.97–$2.07 billion, excluding the upper portion.
- Hexcel acquired the remaining 50% of Formax in January 2016 and made or committed to investments in Oxford Performance Materials and Luminati Aerospace. It also entered a treasury lock with a $150 million notional amount for a forecast 2017 debt issuance.
Key facts for investors to verify
- Whether commercial-aircraft program ramps, especially A350 XWB, continue at expected rates and translate into profitable growth.
- Whether start-up costs, higher depreciation and Engineered Products program transitions continue to pressure margins.
- Whether the 2016 free-cash-flow and capital-expenditure outlook was achieved, given planned capacity expansion.
- How increased borrowing, repurchases and dividends affect net debt, interest expense and covenant headroom.
- Whether uncertain tax benefits recur and how environmental liabilities, particularly the Passaic River matter, develop.