Hexcel Corporation — Q3 2019 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, 2019, compared with the corresponding 2018 periods.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $572.5 million | $540.5 million | $1,791.4 million | $1,628.1 million |
| Gross margin | $157.9 million; 27.6% | $143.0 million; 26.5% | $493.9 million; 27.6% | $430.4 million; 26.4% |
| Operating income | $109.9 million; 19.2% margin | $96.5 million; 17.9% margin | $327.8 million; 18.3% margin | $275.4 million; 16.9% margin |
| Net income | $80.3 million | $80.1 million | $233.4 million | $210.5 million |
| Diluted EPS | $0.93 | $0.91 | $2.71 | $2.35 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $277.3 million | $278.4 million |
| Free cash flow | Not provided for quarter | Not provided for quarter | $114.6 million | $128.2 million |
For the first nine months, capital expenditures were $162.7 million versus $150.2 million. Working capital used $83.7 million of cash, compared with $64.6 million in the prior-year period. Cash and equivalents were $47.0 million at September 30, 2019.
Total debt was $1,124.5 million, or $1,077.5 million net of cash, compared with net debt of $924.1 million at December 31, 2018. Long-term debt was $1,115.2 million. The $1 billion revolving credit facility had $379 million drawn and $621 million undrawn; management reported no significant required debt repayments until the facility matures in June 2024. Total current assets were $771.6 million and current liabilities $347.0 million.
Material changes and drivers
- Q3 sales grew 5.9% year over year, or 6.6% in constant currency; nine-month sales rose 10.0%, or 11.2% in constant currency.
- Space and Defense sales increased 21.5% in Q3, principally from the F-35 program and the ARC acquisition. Commercial Aerospace rose 3.4%, with strength in A320neo and B787 partly offset by reduced Boeing 737 MAX demand. Industrial sales were approximately flat in Q3.
- Engineered Products sales increased 15.6% in Q3 and 21.9% year to date, primarily reflecting the ARC Technologies acquisition and program growth. Hexcel acquired ARC for $163.2 million in January 2019, funding the purchase in part with borrowings; the acquisition added $145.1 million of goodwill and intangible assets.
- Operating income and margins improved. Management attributed the gross-margin comparison partly to 2018 headwinds from acrylonitrile and wind-energy resin pricing, while maintaining cost control and continuing investment in research and technology.
- Q3 net income was nearly unchanged despite higher operating income, as the effective tax rate increased to 18.4% from 9.1%. The 2018 quarter included $9.6 million of discrete tax benefits; 2019 included $3.0 million of tax-credit benefits. Nine-month effective tax rates were 21.3% and 16.9%, respectively.
Outlook, risks and unusual items
- Management expected 2019 accrual-basis capital expenditures of $170 million to $190 million and said short-term liquidity needs, including capex, were expected to be met through operating cash flow, cash on hand and the credit facility. The filing does not provide a clear full-year revenue or EPS guidance figure.
- Management’s underlying estimated effective tax rate was expected to remain at 24%.
- Key business risks include changes in aircraft production and deliveries, especially Boeing 737 MAX production; customer concentration; defense budgets and program changes; raw-material availability and cost; supply-chain disruption; capacity expansion and qualification execution; currency movements; trade and Brexit uncertainty; competition; and cybersecurity risks.
- Environmental reserves totaled $2.5 million. For sites where liability could be estimated, the reserve would have been approximately $16 million higher if measured at the high end of the range of possible outcomes. Hexcel is among parties involved in litigation concerning the Lower Passaic River; the ultimate allocation and liability remain uncertain. Management stated pending proceedings were not expected to have a material adverse impact based on information available.
- Foreign-currency and commodity hedges generated reported losses and contributed to other comprehensive loss; currency translation and financial-instrument effects reduced Q3 comprehensive income to $37.3 million from $79.3 million. The filing also reflects adoption of lease accounting, adding $67.5 million of right-of-use assets and related liabilities at quarter-end.
Investor verification points
- Assess the durability of aerospace growth and the extent of exposure to Boeing 737 MAX production and customer delivery schedules.
- Separate organic growth from the ARC acquisition’s contribution, especially in Engineered Products and Space and Defense.
- Track working-capital investment, free cash flow, and whether planned capital spending converts into operating capacity and returns.
- Monitor net debt, facility utilization, covenant headroom, interest expense, and the effects of the acquisition on leverage.
- Review the tax-rate outlook and discrete tax items, along with environmental reserve uncertainty and hedge-related earnings effects.