Hexcel Corporation — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010; financial statements are unaudited. Hexcel develops and manufactures advanced composite materials and engineered products for commercial aerospace, space and defense, and industrial markets.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $294.5 million | $257.1 million | $862.6 million | $841.7 million |
| Gross margin | $70.5 million; 23.9% | $52.1 million; 20.3% | $215.0 million; 24.9% | $192.2 million; 22.8% |
| Operating income | $34.5 million | $19.6 million | $98.8 million | $89.2 million |
| Operating margin | 11.7% | 7.6% | 11.5% | 10.6% |
| Net income | $15.6 million | $10.4 million | $54.5 million | $50.6 million |
| Diluted earnings per share | $0.16 | $0.11 | $0.55 | $0.52 |
| Net interest expense | $5.3 million | $6.9 million | $19.0 million | $19.8 million |
- Quarterly sales rose 14.5% year over year, or 18.2% in constant currency; nine-month sales rose 2.5%, or 3.2% in constant currency.
- Commercial aerospace sales grew 23.6% in Q3 and 12.3% year to date. Space and defense was essentially flat in both periods. Industrial sales increased 13.4% in Q3 but declined 15.5% year to date.
- Management attributed the higher gross margin to increased volume, factory productivity, cost reductions, and favorable product mix. Foreign exchange added about 50 basis points to Q3 gross margin improvement.
- Adjusted operating income was $34.5 million for Q3 and $102.3 million year to date. Adjusted net income was $19.9 million and $57.5 million, respectively. These are non-GAAP measures; Q3 adjusted net income excludes the after-tax refinancing charge.
Cash flow, debt, and liquidity
- Operating cash flow for the first nine months was $68.8 million, compared with $140.0 million in 2009. Accounts receivable and inventory used $71.2 million of cash, versus a $77.0 million source in the prior-year period.
- Capital expenditure cash payments were $31.2 million, versus $82.1 million. Management reported free cash flow of approximately $38 million, compared with almost $58 million a year earlier.
- Cash was $78.5 million at September 30, 2010, down from $110.1 million at year-end 2009. Total debt was $331.6 million, down from $392.3 million; debt net of cash was $253.1 million, a $29.1 million decrease from year-end.
- In July, Hexcel refinanced with a $250 million senior secured facility: a $150 million revolver and a $100 million term loan, maturing in 2015. No revolving borrowings were outstanding; availability was $147.9 million after letters of credit. The company also had $5.0 million drawn on a China credit line.
- Hexcel reported compliance with debt covenants at quarter-end and expected continued compliance. The facility requires minimum interest coverage of 4.00 and a maximum leverage ratio of 3.00.
Changes, outlook, and notable items
- Q3 net income included a $6.8 million pretax charge to accelerate amortization of financing costs on the replaced credit facility ($4.3 million after tax in the company’s reconciliation). The refinancing lowered the stated borrowing margin by 125 basis points and removed the prior 2.5% LIBOR floor.
- Nine-month 2010 results included a $3.5 million environmental reserve expense and a $3.5 million clean-energy tax credit benefit. The 2009 comparison included a $1.7 million gain on a prior business sale and a $1.7 million environmental expense.
- Management expected full-year 2010 accrued capital expenditures of $60–$65 million, with spending increasing in Q4. Construction of carbon-fiber capacity additions had resumed; completion was expected by the end of 2011, bringing nameplate capacity to 16 million pounds.
- Management cited aircraft production rates and new programs as growth drivers, but noted Boeing 787 and 747-8 delivery delays and said their effect on Hexcel sales was unclear. It described near-term wind-energy demand as choppy, despite optimism about longer-term prospects.
- Risks include customer and aircraft-program dependence, changes in aerospace and defense demand, industrial-market volatility, foreign-exchange and interest-rate movements, raw-material supply constraints, execution of capacity expansions and cost initiatives, and environmental and litigation exposure. Management stated that currently estimated aggregate contingent liabilities, after insurance and accrued amounts, were not expected to have a material adverse effect; some individual exposures remain indeterminable.
Contingencies and controls
- Environmental accruals totaled $8.6 million at quarter-end, including $5.9 million for the Lodi, New Jersey site. Hexcel’s ultimate liability for the Lower Passaic River matter cannot be determined; EPA study alternatives cited in the filing ranged from $900 million to $2.3 billion, amounts relating to the broader site options and not identified as Hexcel’s liability.
- Seemann Composites sought unspecified compensatory damages and $10 million in punitive damages; Hexcel said it would defend the case. The ultimate liability was undetermined.
- Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting. The filing stated there were no material changes in market risk from the 2009 Form 10-K.
Important facts for investors to verify
- Whether commercial aerospace growth and aircraft production assumptions hold, particularly given program delivery delays and customer concentration.
- Whether sales recovery translates into operating cash flow as working capital rebuilds, and whether projected capital spending remains within the $60–$65 million range.
- Progress, cost, and timing of carbon-fiber capacity additions and the expected effect on utilization and margins.
- Debt repayment, covenant headroom, and liquidity under the refinanced facility, including the impact of variable interest rates.
- Changes in environmental reserves and the status of Lower Passaic River, Kent, Omega, and product-liability matters.
- How reported GAAP results compare with non-GAAP adjusted results and the effects of tax credits, refinancing charges, environmental expenses, and foreign exchange.