Business Context and Reporting Period
Company: Hexcel Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2008
Business Overview: Hexcel is a leading advanced composites company manufacturing lightweight, high-performance materials for commercial aerospace, space and defense, and industrial applications. The company operates through two segments: Composite Materials and Engineered Products.
Key Financial Metrics
| Metric (in millions) | Q2 2008 | Q2 2007 | 6-Month 2008 | 6-Month 2007 |
|---|---|---|---|---|
| Net Sales | $359.5 | $289.8 | $704.0 | $572.4 |
| Gross Margin | $76.1 (21.2%) | $70.4 (24.3%) | $156.2 (22.2%) | $141.9 (24.8%) |
| Operating Income | $29.3 | $34.0 | $65.7 | $63.9 |
| Net Income | $26.7 | $8.8 | $49.9 | $32.3 |
| Diluted EPS | $0.27 | $0.09 | $0.51 | $0.33 |
| Cash and Equivalents | $19.3 | $28.1 | $19.3 | $25.7 |
| Total Debt | $395.5 | $315.9 | $395.5 | $315.9 |
| Operating Cash Flow (6mo) | ($5.5) Used | $27.0 Provided | ($5.5) Used | $27.0 Provided |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 24.1% in Q2 2008 and 23.0% for the six months ended June 30, 2008, compared to the prior year. Growth was driven by commercial aerospace (up 28.5% in Q2) and space/defense (up 26.6% in Q2).
- Profitability: While net income increased significantly (52.6% in Q2), operating income decreased 13.8% in Q2 2008 compared to Q2 2007. This decline was primarily due to a $7.6 million environmental remediation charge and lower gross margins.
- Gross Margin Compression: Gross margin percentage declined from 24.3% to 21.2% in Q2 2008. Factors included start-up costs for new facilities in Spain, France, Germany, and China; unfavorable foreign exchange rates; and rising commodity costs (oil, utilities, freight).
- Debt Structure: In May 2008, the company borrowed $80 million in new term loans (Term C) to pay down its revolving credit facility, restoring revolver availability. Total debt increased from $315.9 million to $395.5 million.
- Cash Flow: Operating cash flow turned negative ($5.5 million used) for the first six months of 2008, compared to $27.0 million provided in the prior year. This was driven by a $42.9 million increase in accounts receivable and working capital needs associated with sales growth.
Guidance, Outlook, and Risks
- Outlook: Management states demand remains robust despite economic news. The company is executing ambitious capacity expansion plans, including a new greenfield site in Spain, prepreg facilities in Germany and France, and glass prepreg plants in China and Colorado.
- Major Contract: Hexcel announced it will supply carbon fiber prepregs for major primary structures on the new Airbus A350, a contract potentially generating $4-5 billion in revenue over its life.
- Capital Expenditures: Projected capital expenditures for 2008 were raised from $150 million to $175 million to support fiber expansion.
- Foreign Exchange Risk: The weakening U.S. dollar significantly impacted results. A 5% movement in the dollar is estimated to increase annualized sales by ~$25 million but decrease operating income by ~$1 million due to translation effects on European costs.
- Environmental Contingency: A $7.6 million charge was recorded for the Lodi, New Jersey site remediation. The estimated total cost range is $7.9 million to $11.5 million.
- Legal Proceedings: Hercules Incorporated is seeking indemnification for antitrust liabilities. While a lower court dismissed the claim, Hercules has requested a review by the New York Court of Appeals. No reserve has been recorded.
- Subsequent Event: On July 18, 2008, Hexcel sold its 40.48% interest in BHA Aero Composite Parts Co., Ltd. to Boeing for $22.3 million, expecting an after-tax gain of approximately $12 million in Q3 2008.
Investor Verification Checklist
- Environmental Accruals: Verify the assumptions behind the $7.6 million Lodi site remediation charge and the potential exposure up to $11.5 million.
- Working Capital Trends: Monitor the $42.9 million increase in accounts receivable and its impact on future operating cash flow.
- Capacity Expansion ROI: Assess the timeline for new facilities (Spain, France, Germany, China, Colorado) to reach profitability and offset start-up costs.
- Foreign Exchange Sensitivity: Evaluate the impact of continued dollar weakness on gross and operating margins, given the significant European cost base.
- Legal Indemnity: Track the status of the Hercules indemnity claim and potential liability exposure.
- Debt Covenants: Confirm compliance with the Senior Secured Credit Facility covenants (minimum interest coverage ratio of 4.00 and maximum leverage ratio of 3.00).