Hexcel Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Hexcel develops and manufactures advanced composite materials and structures, serving Commercial Aerospace, Space & Defense, and Industrial markets.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $547.5m | $491.3m | $1,087.6m | $970.1m |
| Gross margin | $144.8m; 26.4% | $139.9m; 28.5% | $287.4m; 26.4% | $274.0m; 28.2% |
| Operating income | $96.5m; 17.6% margin | $89.7m; 18.3% margin | $178.9m; 16.4% margin | $168.3m; 17.3% margin |
| Net income | $68.8m | $61.6m | $130.4m | $126.2m |
| Diluted EPS | $0.76 | $0.67 | $1.44 | $1.37 |
- Q2 sales grew 11.4% reported and 10.3% in constant currency; first-half sales grew 12.1% reported and 10.3% in constant currency. Q2 diluted EPS rose 13.4%; first-half diluted EPS rose 5.1%.
- Sales growth spanned all markets. Q2 Commercial Aerospace sales rose 10.0%, Space & Defense 4.4%, and Industrial 32.1%. Management cited aircraft production and composite-content increases, stronger business-jet sales, rotorcraft demand, and wind-energy growth.
- Gross and operating margins declined year over year despite higher sales. Management attributed gross-margin pressure in 2018 to increased depreciation and amortization and startup costs at its new France facility. First-half depreciation and amortization was $10.1m higher than a year earlier.
- Operating cash flow was $157.2m versus $182.4m. Capital expenditures were $101.9m versus $169.2m, yielding reported free cash flow of $55.3m versus $13.2m. Working capital used $60.2m of cash, compared with $7.1m in the prior-year period.
- Cash was $39.1m at June 30, 2018, down from $60.1m at year-end 2017. Total debt was $939.4m and net debt was $900.3m, compared with year-end net debt of $749.8m. The company had $515m available under its $700m revolving facility and reported compliance with debt covenants.
- Share repurchases and dividends totaled $203m in the first half. The board authorized an additional $500m share repurchase program on May 7, 2018. Quarterly dividends were $0.125 per share.
Changes, outlook, and risks
- Management expects 2018 capital expenditures of $170m–$190m on an accrual basis. No specific revenue or earnings guidance is provided in the supplied filing text.
- Interest expense rose 27.9% in Q2 and 28.5% in the first half, principally due to higher debt; management also cited higher interest rates for the first-half increase. The company expects to fund near-term liquidity needs from operating cash flow, cash, and its credit facility, and reported no significant required debt repayments before the facility matures in 2021.
- Tax rates include period-specific items: Q2 2018 benefited from a $1.3m release of uncertain-tax-position reserves; first-half 2017 benefited from a $9.1m foreign valuation-allowance release. Excluding discrete benefits, first-half effective rates were 21.8% in 2018 and 25.7% in 2017.
- ASC 606 was adopted January 1, 2018, with a $3.8m opening retained-earnings adjustment. The filing says its impact on reported results was not significant; Q2 revenue was $2.8m higher and gross margin $0.6m higher than under the prior standard.
- Q2 comprehensive loss was $4.2m despite net income of $68.8m, primarily reflecting currency translation and derivative-related losses in other comprehensive income. A separate note describes $7.3m of Q2 items related to an environmental insurance recovery, an investment write-down, and an additional environmental reserve; the income statement reports no net other operating income or expense.
- Environmental reserves totaled $2.9m. The Lower Passaic River allocation and remediation remain uncertain; the company estimated its accrual at the low end of ranges where no amount was a better estimate, and noted that accruals could have been $16m higher at the high end of applicable ranges. The EPA’s stated remedy cost for the lower eight miles is $0.97bn–$2.07bn, excluding the upper portion.
- Newly highlighted risk: tariffs or retaliatory trade measures could increase input costs or make U.S.-produced goods more expensive abroad; the impact and duration were uncertain. Other cited risks include aircraft production and customer demand, program delays, supply constraints, foreign exchange, labor disruptions, and environmental and regulatory developments.
Key facts for investors to verify
- Whether sales growth converts into margin improvement as France startup costs and higher depreciation affect results.
- Working-capital trends, cash conversion, and delivery of the stated 2018 capital expenditure plan.
- Debt and share-repurchase trajectory, including facility availability, covenant headroom, and the effect of buybacks on net debt and interest expense.
- Aircraft build rates, business-jet demand, defense programs, wind-energy growth, and any tariff-related cost or customer effects.
- Progress and potential exposure in the Lower Passaic River and other environmental matters, including insurance recovery and allocation outcomes.
- Tax-rate developments and the continued effects of ASC 606 and foreign-currency movements.