Hexcel Corporation (HXL) — Q2 2020 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2020. Hexcel makes advanced composite materials and engineered products, primarily for commercial aerospace, space and defense, and industrial markets. The period was heavily affected by the COVID-19 pandemic.
Financial results
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Net sales | $378.7 million | $609.0 million | $919.7 million | $1,218.9 million |
| Gross margin | $54.9 million; 14.5% | $168.8 million; 27.7% | $195.8 million; 21.3% | $336.0 million; 27.6% |
| Operating income | $6.4 million; 1.7% margin | $115.1 million; 18.9% margin | $72.1 million; 7.8% margin | $217.9 million; 17.9% margin |
| Net income (loss) | $(1.0) million | $80.9 million | $41.4 million | $153.1 million |
| Diluted EPS | $(0.01) | $0.94 | $0.49 | $1.78 |
| Operating cash flow | Not reported quarterly | Not reported quarterly | $73.6 million | $157.2 million |
| Capital expenditures | Not reported quarterly | Not reported quarterly | $40.4 million | $99.3 million |
Q2 revenue fell 37.8% year over year and first-half revenue fell 24.5%. Commercial Aerospace was the principal source of weakness: Q2 sales declined 51.0% to $203.9 million. Space & Defense Q2 sales decreased 3.0% to $108.4 million; Industrial sales declined 17.7% to $66.4 million. The filing attributes margin pressure to lower demand and an unfavorable mix, including reduced carbon-fiber sales.
At June 30, cash and cash equivalents were $257.2 million, versus $64.4 million at year-end 2019. Total debt was $1,265.2 million, up from $1,060.1 million; debt net of cash was $1,008.0 million, versus $995.7 million at year-end. The $1 billion revolving facility had $568 million drawn and $432 million undrawn availability. Current assets were $849.6 million and current liabilities $219.9 million.
Changes, unusual items, and outlook
- Q2 included $13.1 million of other operating expense, primarily restructuring costs related to workforce reductions. First-half other operating expense was $27.8 million and also included costs for the terminated Woodward merger. Adjusted operating income, excluding these expenses, was $19.5 million for Q2 and $99.9 million for the first half; these are non-GAAP measures.
- Hexcel terminated its proposed all-stock merger with Woodward on April 5, 2020, citing the pandemic’s impact. It also adopted a stockholder rights plan on April 6, 2020; the rights were not exercisable as of June 30 and were set to expire April 6, 2021.
- Management reported cost actions including temporary salary reductions, unpaid furloughs, and elimination of more than 1,500 jobs. It said these measures reduced labor costs by approximately 30%. The company curtailed discretionary spending and suspended dividend payments and share repurchases.
- The company expected the pandemic to continue to hurt results, but said the financial impact could not be reasonably estimated. It gave no quantified sales or earnings guidance. Management expected an underlying full-year effective tax rate of approximately 23%, excluding the reported discrete tax benefit.
- The first-half cash-flow table shows operating cash flow of $73.6 million less capital expenditures of $40.4 million, implying positive free cash flow of $33.2 million. However, the MD&A text describes free cash flow as a “use” of $33.2 million, an inconsistency in the filing. The comparable 2019 amount is shown as $57.9 million.
Risks, liquidity, and contingencies
The filing highlights uncertainty from commercial aircraft production cuts, reduced air travel, inventory reductions across the supply chain, customer and supplier disruptions, and possible facility closures. Hexcel noted its dependence on Airbus and Boeing: approximately 68% of 2019 sales came from commercial aerospace customers. Management expected to meet short-term liquidity needs through operating cash flow, cash on hand, and the revolving facility; it reported no significant required debt repayments before the facility matures in June 2024. Facility covenants include a minimum interest coverage ratio of 3.50 and maximum leverage ratio of 3.75, subject to specified terms.
Environmental accruals totaled $2.6 million. For sites where it could estimate liability, the company said accruals would have been about $16 million higher if measured at the high end of possible outcomes. It also reported ongoing litigation and environmental matters, including the Lower Passaic River proceeding, while stating that pending proceedings were not expected to have a material adverse effect based on information currently available.
Important facts for investors to verify
- Whether commercial aerospace build rates, particularly Airbus and Boeing programs, and supply-chain inventory levels recover or deteriorate further.
- How quickly cost reductions and workforce actions affect margins, operating capacity, and customer delivery commitments.
- The free-cash-flow discrepancy: the reported figures calculate to positive $33.2 million, while narrative text calls it a use.
- Available revolver capacity, covenant headroom, and the effect of weaker earnings on leverage and interest coverage.
- Potential changes in environmental liabilities, especially the Lower Passaic River allocation and remediation process.
- Whether the expected 23% underlying tax rate and the suspended dividend and repurchases remain applicable in subsequent periods.