Hexcel Corporation — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Hexcel manufactures advanced composite materials and engineered products for commercial aerospace, space and defense, and industrial markets. Amounts are in U.S. dollars; financial statements are unaudited.
Financial results and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $305.1 million | $277.3 million | $568.1 million | $584.6 million |
| Gross margin | $78.4 million; 25.7% | $63.1 million; 22.8% | $144.5 million; 25.4% | $140.1 million; 24.0% |
| Operating income | $40.5 million | $29.7 million | $64.3 million | $69.6 million |
| Net income | $23.1 million | $16.8 million | $38.9 million | $40.2 million |
| Diluted EPS | $0.23 | $0.17 | $0.39 | $0.41 |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $31.7 million | $86.2 million |
- Q2 sales rose 10.0% reported and 12.0% in constant currency; operating income increased 36.4% and net income 37.5%. The quarter’s operating margin was 13.3%, versus 10.7%.
- For the first half, sales declined 2.8% reported and 3.2% in constant currency. Operating income fell 7.6%; net income fell 3.2%. Adjusted first-half operating income was $67.8 million versus $71.3 million, and adjusted net income was $37.6 million versus $41.3 million. These are company-defined non-GAAP measures.
- First-half free cash flow, defined by Hexcel as operating cash flow less capital expenditures, was $11.6 million versus $22.0 million. Working capital absorbed cash as sales recovered: receivables and inventories used $81.2 million combined, partly offset by a $36.9 million inflow from payables and accrued liabilities.
- At June 30, cash was $84.0 million; total debt was $363.8 million and debt net of cash was $279.8 million. Current assets were $488.7 million and current liabilities $194.1 million. Total liabilities were $651.6 million.
- First-half capital expenditures were $20.1 million on a cash basis; accrual-basis additions were $13.7 million, compared with $47.9 million in the prior-year period. The filing revised the 2009 cash-flow presentation: operating cash flow for first-half 2009 is $86.2 million, revised from $69.9 million, with investing cash flow correspondingly reclassified.
Material changes and operating drivers
- Commercial aerospace was the main growth driver: Q2 sales increased 16.8% reported (18.1% constant currency), with Airbus- and Boeing-related sales up about 20%. New aircraft programs accounted for more than 20% of commercial aerospace sales in the quarter.
- Space and defense sales rose 6.3% in Q2 but were essentially flat for the first half. Rotorcraft sales, including V-22, offset lower F-22 sales as that program approaches its end.
- Industrial sales were essentially flat in Q2 but down 26.8% for the first half. Wind-energy sales rebounded after a major customer’s first-quarter inventory correction.
- Management attributed improved Q2 gross margin to higher volume, factory productivity, cost reductions, favorable mix, and roughly 50 basis points of foreign-exchange benefit. Higher depreciation partly offset these gains.
- Q2 SG&A rose 17.0% to $29.6 million, primarily reflecting higher incentive and stock-based compensation. Research and technology expense rose 29.7% to $8.3 million, reflecting development and qualification work for new aircraft programs.
Outlook, financing, risks and contingencies
- Management expected continued double-digit sales growth in constant currency through the rest of 2010, led by commercial aerospace. It cited the end of inventory corrections, modestly higher large-aircraft build-rate announcements, and progress on new programs. Hexcel expected to remain free-cash-flow positive for 2010 and keep full-year capital expenditures below $75 million, with spending increasing in the second half.
- Hexcel had resumed construction of remaining carbon-fiber capacity additions and expected completion by the end of 2011, bringing nameplate capacity to 16 million pounds.
- On July 9, 2010, after quarter-end, Hexcel refinanced its existing facility with a $250 million senior secured facility: a $150 million revolver and a $100 million term loan, maturing in 2015. No revolver borrowings were outstanding at closing; $146.7 million was available after letters of credit. Management expected interest costs to decrease by more than $5 million over the next 12 months at then-current borrowing levels and forecast LIBOR. Refinancing will cause a $6.8 million third-quarter charge for accelerated amortization of old financing costs; new issuance costs were about $3.7 million. The facility includes leverage and interest-coverage covenants and capital-spending limits.
- First-half results included a $3.5 million environmental-reserve charge and a $3.5 million clean-energy manufacturing tax credit. The credit reduced the reported first-half effective tax rate to 23.9%; excluding it, the rate would have been 30.8%. Q2 effective tax rate was 31.7%.
- Environmental accruals totaled $9.7 million at June 30, including $6.9 million for remediation of the former Lodi, New Jersey site. Hexcel reported that its ultimate liability for the Lower Passaic River matter could not be determined; the EPA’s estimated remedial options ranged from $900 million to $2.3 billion, but the filing does not quantify Hexcel’s potential share. The company said its other legal and contingent liabilities, after insurance and existing accruals, were not expected to materially affect consolidated results, financial position, or cash flows.
- Key disclosed risks include aircraft production rates and program delays or cancellations, defense-budget changes, customer concentration, industrial and wind-market volatility, foreign-exchange and interest-rate movements, raw-material supply and costs, manufacturing capacity, competition, and environmental or litigation outcomes. Hexcel reported effective disclosure controls and no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether the projected double-digit constant-currency growth, positive full-year free cash flow, and sub-$75 million capital-spending outlook were achieved.
- How quickly commercial aerospace programs and aircraft build rates translated into sustained sales, and whether F-22 and later C-17 program run-offs were offset by other defense programs.
- Working-capital requirements and cash conversion as sales grew, given the first-half cash use for receivables and inventories.
- Actual interest savings, covenant headroom, debt repayment, and the third-quarter $6.8 million refinancing-related charge.
- Changes in environmental reserves and developments in the Lower Passaic River, Kent, and other matters, including any estimate of Hexcel’s potential exposure.
- Effects of foreign-exchange movements and the $3.5 million tax credit when comparing reported and adjusted results.