Hexcel Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Hexcel develops and manufactures advanced composite materials and structures for commercial aerospace, space and defense, and industrial markets. Figures are in U.S. dollars; financial statements are unaudited.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 / prior date |
|---|---|---|
| Net sales | $540.1 million | $478.8 million; up 12.8% (10.2% in constant currency) |
| Gross margin | $142.6 million; 26.4% | $134.1 million; 28.0% |
| Operating income / margin | $82.4 million / 15.3% | $78.6 million / 16.4% |
| Net income | $61.6 million | $64.6 million |
| Diluted EPS | $0.68 | $0.70 |
| Adjusted net income / diluted EPS (non-GAAP) | $61.6 million / $0.68 | $55.5 million / $0.60 |
| Operating cash flow | $62.6 million | $54.2 million |
| Capital expenditures (cash basis) | $59.5 million | $85.5 million |
| Free cash flow (non-GAAP) | $3.1 million | $(31.3) million |
| Cash / total debt | $49.8 million / $840.0 million | $60.1 million / $809.9 million at Dec. 31, 2017 |
| Net debt | $790.2 million | $749.8 million at Dec. 31, 2017 |
Revenue grew across all end markets: Commercial Aerospace $382.7 million (+10.2%), Space & Defense $90.1 million (+17.5%), and Industrial $67.3 million (+22.6%). Commercial Aerospace growth included the A320neo, 737 MAX and A350; F-35 and military rotorcraft supported Space & Defense; wind energy sales improved as new-generation blade production began.
Liquidity included $622 million of undrawn availability on the $700 million revolving facility. Hexcel reported compliance with debt covenants and expects short-term liquidity needs, including capital expenditures, to be met with operating cash flow, cash on hand and the facility. Total debt increased mainly alongside share repurchases and dividends; the filing reports no significant required debt repayments until the facility matures in 2021.
Changes and notable items
- Sales rose 12.8%, but gross margin fell 1.6 percentage points and operating margin declined 1.1 points. Management attributed margin pressure in part to approximately $5 million of additional depreciation and amortization and startup costs for the new France site; depreciation and amortization overall was $5.4 million higher year over year.
- GAAP net income declined 4.6% and diluted EPS declined from $0.70 to $0.68. The 2017 quarter included a $9.1 million discrete tax benefit from a foreign valuation-allowance release. Excluding that benefit, adjusted net income increased 11.0% and adjusted diluted EPS increased 13.3% (non-GAAP).
- Interest expense increased 29.0% to $8.0 million, reflecting higher debt levels and interest rates, including the 2027 notes issued in 2017. The 2018 effective tax rate was 18.9%; management cited a 25% estimated annual underlying rate excluding discrete items.
- Hexcel adopted ASC 606 using the modified retrospective method. Adoption increased opening contract assets by $38.1 million and adjusted opening retained earnings; the quarter’s reported revenue was $2.9 million lower, gross margin $0.7 million lower, and diluted EPS slightly more than half a cent lower than under prior accounting. Management said the overall effect on financial results was not significant.
- Share repurchases were $30.1 million and dividends paid were $11.2 million. The quarterly dividend was $0.125 per share, versus $0.11 in Q1 2017.
Outlook, risks and contingencies
- Management forecast 2018 accrual-basis capital expenditures of $170 million to $190 million. The filing provides no clear full-year revenue, earnings or EPS guidance.
- Management cited demand and production-rate assumptions for aircraft programs, potential delivery or program ramp-up delays, customer and product mix, capacity additions and ability to sustain margins as factors affecting results. Other identified risks include reliance on major aerospace and wind customers, defense-budget or program changes, supply constraints, foreign-exchange and interest-rate movements, commodity prices, environmental regulation, tax developments, labor disruption, Brexit-related uncertainty, and network or system interruptions.
- Environmental reserves totaled $2.7 million. Hexcel’s Lower Passaic River allocation remains undetermined; the EPA’s estimated remedy cost for the lower eight miles was $0.97 billion to $2.07 billion, excluding the upper river. Hexcel stated its accrual was sufficient based on available information, but noted that accruing at the high end of estimable ranges across certain sites would have increased reserves by $16 million. The company also reported a $0.6 million reserve for the Omega site and regional groundwater matter.
- Management stated that currently known litigation and other contingencies were not expected to have a material adverse effect, while acknowledging that estimates may change. No material change in market risk from the 2017 Form 10-K was reported.
Important facts for investors to verify
- Whether volume, product mix, currency effects, and France-site startup costs support recovery in gross and operating margins.
- Aircraft production and delivery rates, particularly for the A320neo, 737 MAX and A350, and the durability of growth in Space & Defense and wind energy.
- Actual 2018 capital spending versus the $170 million–$190 million estimate and its effect on free cash flow and net debt.
- Future tax-rate effects under the Tax Cuts and Jobs Act and the absence of the prior-year $9.1 million discrete tax benefit.
- Environmental remediation allocation, insurance recovery and potential reserve changes, especially for the Lower Passaic River.
- Revolving-facility covenant headroom and financing costs as debt and interest rates change.