Hexcel Corporation — Q2 2014 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2014, compared with the same 2013 periods. Hexcel manufactures advanced composite materials and engineered products for commercial aerospace, space and defense, and industrial markets.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $470.1M | $422.6M | $931.8M | $839.1M |
| Gross margin | $129.1M; 27.5% | $116.8M; 27.6% | $258.3M; 27.7% | $228.8M; 27.3% |
| Operating income | $75.1M | $71.9M | $149.7M | $134.9M |
| Net income | $50.6M | $48.5M | $100.7M | $92.1M |
| Diluted EPS | $0.51 | $0.48 | $1.01 | $0.90 |
| Cash from operations | — | $110.3M | $108.2M |
Q2 sales rose 11.2% (10.2% in constant currency); first-half sales increased 11.0% (10.0% in constant currency). Q2 GAAP operating income increased 4.5%, including a $6.0M environmental-reserve charge; excluding that item, adjusted operating income was $81.1M, up 12.8%, and adjusted operating margin was 17.3% versus 17.0%. First-half adjusted operating income was $155.7M, up 15.4%, with a 16.7% margin versus 16.1%. These adjusted figures are non-GAAP.
Q2 operating margin was 16.0% versus 17.0%; first-half operating margin was 16.1% in both years. Q2 gross margin was nearly flat year over year; first-half gross margin improved. Management cited higher volume and cost control, partly offset by unfavorable currency effects.
By end market, Q2 commercial aerospace sales rose 14.1% to $308.2M, industrial rose 24.9% to $69.8M, and space and defense fell 4.8% to $92.1M. Commercial aerospace represented 66% of first-half sales. New aircraft programs, particularly A350 and B787 shipments, supported aerospace growth; industrial gains included wind energy. Space and defense was affected by programs winding down or reducing build rates and less predictable ordering.
Cash, debt and liquidity
- Cash was $43.8M at June 30, 2014, down from $65.5M at December 31, 2013. Total debt was $397.8M, versus $295.0M; net debt was $354.0M, versus $229.5M.
- The $600M revolving facility had $395M drawn and $203.2M available; it matures in 2018. Hexcel reported compliance with its debt covenants and expected continued compliance.
- First-half capital expenditures were $119.2M, versus $92.0M. Free cash flow, defined as operating cash flow less capital expenditures, was negative $8.9M, compared with positive $16.2M.
- Working capital absorbed cash, principally from a $49.9M increase in receivables and a $23.6M increase in inventory. Management said short-term liquidity needs, including capital expenditures, would be met through operating cash flow, cash on hand and the facility.
Changes, outlook and material items
- Hexcel repurchased $114.5M of shares in the first half, or 2.76M shares. A new $150M repurchase authorization was approved in June; $145M remained authorized at June 30. Repurchases contributed to higher debt and lower cash.
- Management expected 2014 accrual-basis capital expenditures of $225M–$250M to expand capacity for customer demand. The filing provides no specific full-year revenue or earnings guidance.
- A $6.0M pretax Q2 and first-half charge increased environmental reserves, primarily for the former Lodi, New Jersey facility. Total environmental accruals were $7.2M at June 30, compared with $3.9M at year-end.
- For the Lower Passaic River, the EPA’s revised study proposed cleanup alternatives for the lower eight miles with estimated costs of $0.8B–$3.25B, as well as a no-action alternative. Hexcel had no current obligation to perform that work and had not determined its allocable share. Its accrual reflected the low end of the range; the company said estimated accruals for certain sites could be $28M higher if measured at the high end of possible outcomes.
- Management identified risks including aircraft production-rate changes or delays, customer concentration, defense-program reductions, industrial demand, foreign exchange, supply-chain and capacity constraints, and environmental and legal matters. It stated that existing legal and environmental accruals were believed adequate, but actual costs could exceed estimates.
- Hexcel was evaluating the new revenue-recognition standard issued in May 2014, effective for the company in first-quarter 2017; the impact had not yet been determined.
Important facts for investors to verify
- Whether aerospace program ramp-ups and industrial growth continue, and whether space and defense weakness persists.
- Progress, timing and returns on the capacity expansion and the full-year capital-spending plan.
- Working-capital conversion and free cash flow as sales grow and capital expenditures remain elevated.
- Debt levels, revolver availability, covenant compliance and the pace of further share repurchases.
- Environmental remediation developments, particularly Lodi and the Lower Passaic River, and how resulting estimates may change.
- Effects of currency, aircraft production rates, customer demand and the eventual adoption of the new revenue standard.