================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------- FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended March 31, 1999 or Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission File Number 1-8472 ---------------------- HEXCEL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) Delaware 94-1109521 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.) Two Stamford Plaza 281 Tresser Boulevard Stamford, Connecticut 06901-3238 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE) Registrant's telephone number, including area code: (203) 969-0666 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No - Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan of reorganization confirmed by a US Bankruptcy Court. Yes X No - Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. <TABLE> <CAPTION> CLASS OUTSTANDING AT MAY 12, 1999 ----- --------------------------- <S> <C> COMMON STOCK 36,447,730 </TABLE> ================================================================================
HEXCEL CORPORATION AND SUBSIDIARIES INDEX <TABLE> <CAPTION> PAGE <S> <C> PART I. FINANCIAL INFORMATION ITEM 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets -- March 31, 1999 and December 31, 1998 2 Condensed Consolidated Statements of Operations -- The Quarters Ended March 31, 1999 and 1998 3 Condensed Consolidated Statements of Cash Flows -- The Quarters Ended March 31, 1999 and 1998 4 Notes to Condensed Consolidated Financial Statements 5 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 26 PART II. OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-K 27 SIGNATURE 28 </TABLE> 1
PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS HEXCEL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------------- UNAUDITED ------------------------------------ MARCH 31, DECEMBER 31, (IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 1998 - ----------------------------------------------------------------------------------------------------------------- <S> <C> <C> ASSETS Current assets: Cash and cash equivalents $ 2,458 $ 7,504 Accounts receivable 199,884 188,368 Inventories 204,748 213,199 Prepaid expenses and other assets 7,469 10,111 Deferred tax asset 21,249 19,844 - ----------------------------------------------------------------------------------------------------------------- Total current assets 435,808 439,026 Property, plant and equipment 623,245 628,533 Less accumulated depreciation (202,052) (195,960) - ----------------------------------------------------------------------------------------------------------------- Net property, plant and equipment 421,193 432,573 Goodwill and other purchased intangibles, net of accumulated amortization of $14,963 in 1999 and $11,742 in 1998 421,422 425,405 Investment in affiliated companies and other assets 118,564 107,157 - ----------------------------------------------------------------------------------------------------------------- Total assets $ 1,396,987 $ 1,404,161 - ----------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable and current maturities of capital lease obligations $ 22,381 $ 26,867 Accounts payable 82,703 81,869 Accrued liabilities 111,094 110,708 - ----------------------------------------------------------------------------------------------------------------- Total current liabilities 216,178 219,444 Long-term notes payable and capital lease obligations 812,869 802,376 Indebtedness to a related party 23,849 35,675 Other non-current liabilities 42,969 44,267 - ----------------------------------------------------------------------------------------------------------------- Total liabilities 1,095,865 1,101,762 Stockholders' equity: Preferred stock, no par value, 20,000 shares authorized, no shares issued or outstanding in 1999 and 1998 - - Common stock, $0.01 par value, 100,000 shares authorized, shares issued and outstanding of 37,264 in 1999 and 37,176 in 1998 373 372 Additional paid-in capital 271,991 271,469 Retained earnings 40,103 34,898 Accumulated other comprehensive income (loss) (692) 6,313 - ----------------------------------------------------------------------------------------------------------------- 311,775 313,052 Less - treasury stock, at cost, 847 shares in 1999 and 1998 (10,653) (10,653) - ----------------------------------------------------------------------------------------------------------------- Total stockholders' equity 301,122 302,399 - ----------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 1,396,987 $ 1,404,161 - ----------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------- </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 2
HEXCEL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------------- UNAUDITED ---------------------------------- QUARTER ENDED MARCH 31, (IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 1998 - ----------------------------------------------------------------------------------------------------------------- <S> <C> <C> Net sales $ 316,170 $ 256,741 Cost of sales 245,399 190,645 - ----------------------------------------------------------------------------------------------------------------- Gross margin 70,771 66,096 Selling, general and administrative expenses 34,338 27,177 Research and technology expenses 6,455 5,183 Business acquisition and consolidation expenses 2,809 - - ----------------------------------------------------------------------------------------------------------------- Operating income 27,169 33,736 Interest expense 19,106 6,967 - ----------------------------------------------------------------------------------------------------------------- Income before income taxes 8,063 26,769 Provision for income taxes 2,839 9,699 Equity in losses of affiliated companies 16 - - ----------------------------------------------------------------------------------------------------------------- Net income $ 5,208 $ 17,070 - ----------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------- Net income per share: Basic $ 0.14 $ 0.46 Diluted 0.14 0.40 Weighted average shares: Basic 36,365 36,845 Diluted 36,460 46,346 - ----------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------- </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 3
HEXCEL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> - ---------------------------------------------------------------------------------------------------------------------- UNAUDITED ------------------------------------- QUARTER ENDED MARCH 31, (IN THOUSANDS) 1999 1998 - ---------------------------------------------------------------------------------------------------------------------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 5,208 $ 17,070 Reconciliation to net cash provided (used) by operations: Depreciation and amortization 15,660 10,008 Deferred income taxes (1,189) (3,720) Accrued business acquisition and consolidation expenses 2,809 - Business acquisition and consolidation payments (2,242) (1,783) Equity in losses of affiliated companies 16 - Working capital changes and other (2,921) (26,676) - ---------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by operating activities 17,341 (5,101) - ---------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (9,429) (11,546) Advances to affiliated companies - (750) - ---------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (9,429) (12,296) - ---------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from (repayments of) the senior and revolving credit facilities, net (229,392) 10,114 Proceeds from (repayments of) long-term debt and capital lease obligations, net 225,719 (505) Debt issuance costs (8,990) - Activity under stock plans 249 1,375 - ---------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities (12,414) 10,984 - ---------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and cash equivalents (544) 553 - ---------------------------------------------------------------------------------------------------------------------- Net decrease in cash and cash equivalents (5,046) (5,860) Cash and cash equivalents at beginning of year 7,504 9,033 - ---------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 2,458 $ 3,173 - ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. 4
HEXCEL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 1 -- BASIS OF ACCOUNTING The accompanying condensed consolidated financial statements have been prepared from the unaudited records of Hexcel Corporation and subsidiaries ("Hexcel" or the "Company") in accordance with generally accepted accounting principles, and, in the opinion of management, include all adjustments necessary to present fairly the balance sheet of the Company as of March 31, 1999, and the results of operations and cash flows for the quarters ended March 31, 1999 and 1998. The condensed consolidated balance sheet of the Company as of December 31, 1998 was derived from the audited 1998 consolidated balance sheet. Certain information and footnote disclosures normally included in financial statements have been omitted pursuant to rules and regulations of the Securities and Exchange Commission. Certain prior quarter amounts in the condensed consolidated financial statements have been reclassified to conform to the 1999 presentation. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 1998 Annual Report on Form 10-K. As discussed in Note 2, Hexcel acquired from Clark-Schwebel, Inc. and its subsidiaries ("C-S") certain assets and assumed certain operating liabilities of its industrial fabrics business (the "Acquired Clark-Schwebel Business") on September 15, 1998. Accordingly, the condensed consolidated balance sheets, statements of operations and cash flows include the financial position, results of operations and cash flows of the Acquired Clark-Schwebel Business as of such date and for such periods that the business was owned by the Company. NOTE 2 -- BUSINESS ACQUISITION On September 15, 1998, the Company acquired certain assets and assumed certain operating liabilities from C-S. The Acquired Clark-Schwebel Business is engaged in the manufacture and sale of high-quality fiberglass fabrics, which are used to make printed circuit boards for electronic equipment such as computers, cellular telephones, televisions and automobiles. The Acquired Clark-Schwebel Business also produces high performance specialty products for use in insulation, filtration, wall and facade claddings, soft body armor and reinforcements for composite materials. At the date of acquisition, the Acquired Clark-Schwebel Business operated four manufacturing facilities in the southeastern U.S. and had approximately 1,300 full time employees. As part of this acquisition, Hexcel also acquired C-S's equity ownership interests in the following three joint ventures: - - a 43.6% share in CS-Interglas AG ("CS-Interglas") headquartered in Germany, together with fixed-price options to increase this equity interest to 84.0%. Hexcel's acquisition of the CS-Interglas equity interest and related options was completed on December 23, 1998; - - a 43.3% share in Asahi-Schwebel Co., Ltd. ("Asahi-Schwebel"), headquartered in Japan, which in turn has its own joint venture with AlliedSignal Inc. in Taiwan; and - - a 50.0% share in Clark-Schwebel Tech-Fab Company ("CS Tech-Fab") headquartered in the United States. 5
CS-Interglas and Asahi-Schwebel are fiberglass fabric producers serving the European and Asian electronics and telecommunications industries. CS Tech-Fab manufactures non-woven materials for roofing, construction and other specialty applications. The fixed-price options to increase the equity interest in CS-Interglas are, in the Company's opinion, significantly higher than their current fair market value and expire on December 31, 1999. The unconsolidated net sales in 1998 for these joint ventures were in excess of $300,000. The acquisition of the Acquired Clark-Schwebel Business was accounted for under the purchase method of accounting and was completed pursuant to an Asset Purchase Agreement dated July 25, 1998, as amended, by and among Hexcel, Stamford CS Acquisition Corp., and C-S (the "Asset Purchase Agreement"). Under the Asset Purchase Agreement, Hexcel acquired the net assets of the acquired business, other than certain excluded assets and liabilities, in exchange for approximately $473,000 in cash. As part of the acquisition, Hexcel entered into a $50,000 lease for property, plant and equipment used in the acquired business from an affiliate of C-S, pursuant to a long-term lease with purchase options. PRO FORMA FINANCIAL INFORMATION The pro forma net sales, net income and diluted net income per share of Hexcel for the quarter ended March 31, 1998, after giving effect to the acquisition of the Acquired Clark-Schwebel Business as if it had occurred on January 1, 1998, were: <TABLE> <CAPTION> - -------------------------------------------------------------------------------------------------------------------- 3/31/98 - -------------------------------------------------------------------------------------------------------------------- <S> <C> Pro forma net sales $ 317,159 Pro forma net income 18,151 Pro forma diluted net income per share $ 0.43 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- </TABLE> NOTE 3 -- INVENTORIES <TABLE> <CAPTION> - -------------------------------------------------------------------------------------------------------------------- 3/31/99 12/31/98 - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Raw materials $ 88,988 $ 90,881 Work in progress 74,439 77,769 Finished goods 41,321 44,549 - -------------------------------------------------------------------------------------------------------------------- Total inventories $ 204,748 $ 213,199 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- </TABLE> NOTE 4 -- NOTES PAYABLE, CAPITAL LEASE OBLIGATIONS AND INDEBTEDNESS TO A RELATED PARTY <TABLE> <CAPTION> - -------------------------------------------------------------------------------------------------------------------- 3/31/99 12/31/98 - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Senior credit facility $ 394,489 $ 618,214 European credit and overdraft facilities 7,843 16,330 Convertible subordinated notes, due 2003 114,435 114,435 Convertible subordinated debentures, due 2011 25,625 25,625 Senior subordinated notes, due 2009 240,000 - Various notes payable 408 547 - -------------------------------------------------------------------------------------------------------------------- Total notes payable 782,800 775,151 Capital lease obligations 52,450 54,092 Senior subordinated note payable to related party, net of unamortized discount of $1,128 and $1,801 as of March 31, 1999 and December 31, 1998, respectively 23,849 35,675 - -------------------------------------------------------------------------------------------------------------------- Total notes payable, capital lease obligations and indebtedness to a related party $ 859,099 $ 864,918 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- </TABLE> 6
<TABLE> <CAPTION> - -------------------------------------------------------------------------------------------------------------------- 3/31/99 12/31/98 - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Notes payable and current maturities of long-term liabilities $ 22,381 $ 26,867 Long-term notes payable and capital lease obligations, less current maturities 812,869 802,376 Indebtedness to related parties 23,849 35,675 - -------------------------------------------------------------------------------------------------------------------- Total notes payable, capital lease obligations and indebtedness to a related party $ 859,099 $ 864,918 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- </TABLE> SENIOR CREDIT FACILITY In connection with the acquisition of the Acquired Clark-Schwebel Business on September 15, 1998, Hexcel obtained a new global credit facility (the "Senior Credit Facility") to: (a) fund the purchase of the Acquired Clark-Schwebel Business; (b) refinance the Company's existing revolving credit facility; and (c) provide for ongoing working capital and other financing requirements of the Company. Simultaneously with the January 1999 closing of the $240,000 principal amount of 9.75% senior subordinated notes due 2009 (the "Senior Subordinated Notes") offering, the Company amended the Senior Credit Facility to, among other things, reduce the available borrowing capacity from $910,000 to $672,000, modify certain financial covenants and to permit the offering. Depending on certain predetermined ratios and other conditions, interest on outstanding borrowings under the Senior Credit Facility is computed at an annual rate ranging from approximately 0.75% to 2.25% in excess of the applicable London interbank rate, or at the option of Hexcel, at 0 to 1.25% in excess of the base rate of the administrative agent for the lenders. In addition, the Senior Credit Facility is subject to a commitment fee ranging from 0.23% to 0.50% per annum of the total facility. The Senior Credit Facility is secured by a pledge of shares of certain of Hexcel's subsidiaries. The Company is subject to various financial covenants and restrictions under the Senior Credit Facility, and is generally prohibited from paying dividends or redeeming capital stock. Approximately $544,000 of the Senior Credit Facility expires in September 2004, with the balance expiring in 2005. SENIOR SUBORDINATED NOTES DUE 2009 On January 21, 1999, the Company issued $240,000 of Senior Subordinated Notes due 2009. The Senior Subordinated Notes are general unsecured obligations of Hexcel that bear interest at a rate of 9.75% per annum. Net proceeds of approximately $231,000 from this offering were used to repay amounts owed under the Senior Credit Facility. The Senior Subordinated Notes are redeemable beginning in January of 2004, in whole or in part, at the option of Hexcel. The redemption prices range from 104.9% to 100.0% of the outstanding principal amount, depending on the period in which redemption occurs. SENIOR SUBORDINATED NOTE PAYABLE TO A RELATED PARTY The senior subordinated note payable to a related party, is payable to Ciba Specialty Chemicals Inc., and is a general unsecured obligation of Hexcel. Ciba Specialty Chemicals Inc. and its affiliate, Ciba Specialty Chemicals Corporation, collectively hold approximately 49.6% of the Company's common stock. From February 28, 1996 through February 28, 1999, the senior subordinated note payable to a related party bore interest at a rate of 7.5% per annum. On February 28, 1999, the interest rate increased to 10.5% per annum, and will continue to increase by an additional 0.5% per year thereafter until they mature in 2003. On February 17, 1999, the Company redeemed $12,500 of the note payable, with such repayment financed with borrowings under the Company's Senior Credit Facility. 7
Over the past few years, the Company has announced two major business consolidation programs. The first one was announced in May 1996 and later revised in December 1996 (the "1996 program"), and primarily related to the integration of the acquired composite business of Ciba-Geigy Ltd. and the acquired carbon fibers and prepreg business of Hercules Inc. In December 1998 and March 1999, the Company announced a second program related to the integration of the Acquired Clark-Schwebel Business and the combination of the Company's U.S., European and Pacific Rim composite materials businesses into a single, global business unit (the "1998/1999 program"). More detailed discussions on each of these programs are set forth below. Total accrued business acquisition and consolidation expenses at December 31, 1998 and March 31, 1999, and activity during the quarter ended March 31, 1999 for each of these programs was as follows: <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------- 1998/1999 1996 PROGRAM PROGRAM TOTAL - ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> BALANCE AS OF DECEMBER 31, 1998 $ 5,002 $ 3,200 $ 8,202 Business acquisition and consolidation expenses 2,809 - 2,809 Cash expenditures (2,242) - (2,242) Non-cash usage, including asset write-downs and currency translation effects (1,927) (100) (2,027) - ----------------------------------------------------------------------------------------------- BALANCE AS OF MARCH 31, 1999 $ 3,642 $ 3,100 $ 6,742 - ----------------------------------------------------------------------------------------------- </TABLE> 1998/1999 PROGRAM In December 1998, Hexcel announced business consolidation actions within its reinforcement products and composite materials businesses. These actions included the integration of Hexcel's existing fabrics business with the U.S. operations of the Acquired Clark-Schwebel Business, and the combination of the Company's U.S., European and Pacific Rim composite materials businesses into a single, global business unit. The objectives of these actions were to eliminate redundancies, improve manufacturing planning, and enhance customer service. As of March 31, 1999, the Company had substantially completed these business consolidation actions and to date, these actions have resulted in the elimination of approximately 100 operating, sales, marketing and administrative positions. On March 16, 1999, the Company expanded its actions relating to the integration of the Acquired Clark-Schwebel Business with the announcement of the closure of its Cleveland, Georgia manufacturing facility by August 1999. This facility, which was part of the Acquired Clark-Schwebel Business, employs approximately 100 people and produces fabrics used to make laminate for printed circuit boards. Certain production equipment from the Cleveland, Georgia facility will be moved to the Company's Anderson, South Carolina facility. Closure of this facility resulted from current competitive conditions in the global market for electronic fiberglass materials and was not expected at the time of the acquisition of the Acquired Clark-Schwebel Business. Accrued business acquisition and consolidation expenses at December 31, 1998 and March 31, 1999, and activity during the quarter ended March 31, 1999 for the 1998/1999 program, were as follows: <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------- EMPLOYEE FACILITY & SEVERANCE & EQUIPMENT 1998/1999 PROGRAM RELOCATION RELOCATION TOTAL - ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> BALANCE AS OF DECEMBER 31, 1998 $ 3,020 $ 1,982 $ 5,002 Business acquisition and consolidation expenses 994 1,815 2,809 Cash expenditures (1,497) (745) (2,242) Non-cash usage, including asset write-downs and currency translation effects - (1,927) (1,927) - ----------------------------------------------------------------------------------------------- BALANCE AS OF MARCH 31, 1999 $ 2,517 $ 1,125 $ 3,642 - ----------------------------------------------------------------------------------------------- </TABLE> 8
As of December 31, 1998, accrued business consolidation and acquisition expenses for the 1998/1999 program primarily consisted of severance for employees terminated in December 1998, costs for early termination for certain leases, and equipment relocation costs incurred, but not yet paid. The Company's policy is to pay severance over a period of time rather than in a lump-sum amount. During the first quarter of 1999, the Company recorded additional business acquisition and consolidation expenses of $2,809, primarily reflecting the costs of closing the Cleveland, Georgia facility, of which $1,800 represented a non-cash write-down on equipment that will be disposed of. Cash expenditures during the quarter ended March 31, 1999 for the 1998/1999 program principally related to severance payments made to those employees terminated in December 1998. As of March 31, 1999, remaining accrued expenses for the 1998/1999 program primarily reflected severance and relocation costs for employees in the Company's Cleveland, Georgia facility and for employees terminated in December 1998, as well as costs relating to the early termination of certain leases. Remaining cash expenditures for the 1998/1999 program are expected to be funded through operating cash flows. The 1998/1999 program is expected to be substantially completed by the end of 1999. 1996 PROGRAM In 1996, Hexcel announced plans to consolidate the Company's operations over a period of three years. The objective of the program was to integrate acquired assets and operations into Hexcel, and to reorganize the Company's manufacturing and research activities around strategic centers dedicated to select product technologies. Management expected that this consolidation program would take approximately three years to complete, in part because of the aerospace industry requirements to "qualify" specific equipment and manufacturing facilities for the manufacture of certain products. These qualification requirements increase the complexity, cost and time of moving equipment and consolidating manufacturing activities. The program is near completion, and the Company expects that all activities related to this consolidation program will be finished by mid-1999. Accrued business acquisition and consolidation expenses at December 31, 1998 and March 31, 1999, and activity during the quarter ended March 31, 1999 for this business acquisition and consolidation program, were as follows: <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------- EMPLOYEE FACILITY & SEVERANCE & EQUIPMENT 1996 PROGRAM RELOCATION RELOCATION TOTAL - ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> BALANCE AS OF DECEMBER 31, 1998 $ 2,848 $ 352 $ 3,200 Non-cash usage, including asset write-downs and currency translation effects (100) - (100) - ----------------------------------------------------------------------------------------------- BALANCE AS OF MARCH 31, 1999 $ 2,748 $ 352 $ 3,100 - ----------------------------------------------------------------------------------------------- </TABLE> As of December 31, 1998 and March 31, 1999, accrued business acquisition and consolidation expenses for the 1996 program related to a $600 foreign government grant received by the Company that is required to be repaid over a five year period due to lower employee levels as a result of the consolidation program, $2,148 in employee retirement costs associated with terminations and $352 of environmental costs related to a closed facility. 9
NOTE 6 -- NET INCOME PER SHARE Computations of basic and diluted net income per share for the quarters ended March 31, 1999 and 1998, are as follows: <TABLE> - -------------------------------------------------------------------------------------------------------------------- 1999 1998 - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Basic net income per share: Net income $ 5,208 $ 17,070 Weighted average common shares outstanding 36,365 36,845 - -------------------------------------------------------------------------------------------------------------------- Basic net income per share $ 0.14 $ 0.46 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- Diluted net income per share: Net income $ 5,208 $ 17,070 Effect of dilutive securities - Senior Subordinated Notes, due 2003 - 1,264 Senior Subordinated Debentures, due 2011 - 283 - -------------------------------------------------------------------------------------------------------------------- Adjusted net income $ 5,208 $ 18,617 - -------------------------------------------------------------------------------------------------------------------- Weighted average common shares outstanding 36,365 36,845 Effect of dilutive securities - Stock options 95 1,428 Senior Subordinated Notes, due 2003 - 7,239 Senior Subordinated Debentures, due 2011 - 834 - -------------------------------------------------------------------------------------------------------------------- Diluted weighted average common shares outstanding 36,460 46,346 - -------------------------------------------------------------------------------------------------------------------- Diluted net income per share $ 0.14 $ 0.40 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- </TABLE> The Convertible Subordinated Notes, due 2003, and the Convertible Subordinated Debentures, due 2011, were excluded from the 1999 computation of diluted net income per share, as they were antidilutive. For the quarter ended March 31, 1999, approximately 4,800 stock options, or substantially all of the Company's outstanding stock options, were excluded from the calculation of diluted net income per share. The exercise price for these stock options ranged from $8.25 to $30.68, with the weighted average price being approximately $12.55. For the quarter ended March 31, 1998, substantially all of the Company's outstanding stock options were included in the calculation of diluted net income per share. NOTE 7 -- COMPREHENSIVE INCOME (LOSS) <TABLE> - -------------------------------------------------------------------------------------------------------------------- QUARTER ENDED MARCH 31, 1999 1998 - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> Net income $ 5,208 $ 17,070 Currency translation adjustment (7,005) (1,573) - -------------------------------------------------------------------------------------------------------------------- Total comprehensive income (loss) $ (1,797) $ 15,497 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- </TABLE> 10
NOTE 8 -- SEGMENT INFORMATION Hexcel evaluates the performance of its operating segments based on adjusted income before business acquisition and consolidation expenses, interest, taxes and equity in earnings of affiliated companies ("Adjusted EBIT"), and generally accounts for intersegment sales based on arm's length prices. Corporate and certain other expenses are not allocated to the operating segments. Financial information on the Company's operating segments for the quarters ended March 31, 1999 and 1998, including pro forma financial information, after giving effect to the acquisition of the Acquired Clark-Schwebel Business as if it occurred on January 1, 1998, is as follows: <TABLE> - -------------------------------------------------------------------------------------------------------------------- REINFORCEMENT COMPOSITE ENGINEERED PRODUCTS MATERIALS PRODUCTS TOTAL - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> FIRST QUARTER 1999 - -------------------------------------------------------------------------------------------------------------------- Net sales to external customers $ 85,807 $ 177,200 $ 53,163 $ 316,170 Intersegment sales 35,728 2,776 - 38,504 - -------------------------------------------------------------------------------------------------------------------- Total sales 121,535 179,976 53,163 354,674 Adjusted EBIT 10,273 26,397 2,596 39,266 Depreciation and amortization 8,902 5,037 1,005 14,944 Capital expenditures 4,189 3,492 1,666 9,347 - -------------------------------------------------------------------------------------------------------------------- PRO FORMA FIRST QUARTER 1998 - -------------------------------------------------------------------------------------------------------------------- Net sales to external customers 103,362 164,133 49,664 317,159 Intersegment sales 35,118 2,946 19 38,083 - -------------------------------------------------------------------------------------------------------------------- Total sales 138,480 167,079 49,683 355,242 Adjusted EBIT 22,344 26,075 2,910 51,329 Depreciation and amortization 9,422 4,249 774 14,445 Capital expenditures 4,772 6,474 900 12,146 - -------------------------------------------------------------------------------------------------------------------- FIRST QUARTER 1998 - -------------------------------------------------------------------------------------------------------------------- Net sales to external customers 42,944 164,133 49,664 256,741 Intersegment sales 35,118 2,946 19 38,083 - -------------------------------------------------------------------------------------------------------------------- Total sales 78,062 167,079 49,683 294,824 Adjusted EBIT 13,679 26,075 2,910 42,664 Depreciation and amortization 4,315 4,249 774 9,338 Capital expenditures $ 3,843 $ 6,474 $ 900 $ 11,217 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- </TABLE> Reconciliations of the totals reported for the operating segments to consolidated income before income taxes, are as follows: <TABLE> - -------------------------------------------------------------------------------------------------------------------- FIRST PRO FORMA FIRST QUARTER FIRST QUARTER QUARTER 1999 1998 1998 - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Total Adjusted EBIT for reportable segments $ 39,266 $ 51,329 $ 42,664 Less: Business acquisition and consolidation expenses 2,809 - - Corporate, other expenses and eliminations 9,288 8,928 8,928 Interest expense 19,106 16,431 6,967 - -------------------------------------------------------------------------------------------------------------------- Consolidated income before income taxes $ 8,063 $ 25,970 $ 26,769 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- </TABLE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BUSINESS OVERVIEW <TABLE> ----------------------------------------------------------------------------------------------------------------- UNAUDITED ----------------------------------------------------------------------------------------------------------------- Quarter Ended March 31, Pro Forma (IN MILLIONS, EXCEPT PER SHARE DATA) 1999 1998 (c) 1998 ----------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Net sales $ 316.2 $ 317.2 $ 256.7 Gross margin % 22.4% 25.6% 25.7% Adjusted operating income % (a) 9.5% 13.4% 13.1% Adjusted EBITDA (b) $ 45.6 $ 57.5 $ 43.7 Business acquisition & consolidation expenses $ 2.8 $ - $ - Net income $ 5.2 $ 18.2 $ 17.1 Adjusted net income (a) $ 7.0 $ 18.2 $ 17.1 ----------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------- Diluted earnings per share $ 0.14 $ 0.43 $ 0.40 Adjusted diluted earnings per share (a) $ 0.19 $ 0.43 $ 0.40 ----------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------- </TABLE> (a) Excludes business acquisition and consolidation expenses and related income taxes, as applicable. (b) Excludes business acquisition and consolidation expenses, interest, taxes, depreciation, amortization and equity in earnings of affiliated companies. (c) Pro forma results gives effect to the September 1998 acquisition of Clark Schwebel, as if the transaction had occurred at the beginning of 1998. Net income for the first quarter of 1999 was $5.2 million, or $0.14 per diluted share, compared with $17.1 million, or $0.40 per diluted share, for the first quarter of 1998. Excluding business acquisition and consolidation expenses of $2.8 million ($1.8 million after tax) incurred in the first quarter of 1999, diluted earnings per share were $0.19. During the first quarter of 1999, demand in most of the markets that Hexcel serves was in line with the Company's expectations, with net sales from commercial aerospace holding steady and lower demand for carbon fiber products. However, pricing in the global market for electronic fiberglass materials remained under intense competitive pressure from certain Asian producers who used the western markets to reduce their significant excess production capacity. The Company's gross margins reflected the impact of higher unit carbon fiber product costs due to lower production, the pricing reductions in the electronics market, and supply chain pricing pressures in the commercial aerospace market. Hexcel remains committed to improving performance by continuing to reduce material costs from suppliers, decrease its own operating costs and increase productivity through its Lean Enterprise, supply-chain and business consolidation initiatives. BUSINESS ACQUISITION On September 15, 1998, the Company acquired certain assets and assumed certain operating liabilities from Clark-Schwebel, Inc. and its subsidiaries (the "Acquired Clark-Schwebel Business"). The Acquired Clark-Schwebel Business is engaged in the manufacture and sale of high-quality fiberglass fabrics, which are used to make printed circuit boards for electronic equipment such as computers, cellular telephones, televisions and automobiles. The Acquired 12
Clark-Schwebel Business also produces high performance specialty products for use in insulation, filtration, wall and facade claddings, soft body armor and reinforcements for composite materials. At the date of acquisition, the Acquired Clark-Schwebel Business operated four manufacturing facilities in the southeastern U.S. and had approximately 1,300 full time employees. 13
As part of this acquisition, Hexcel also acquired Clark-Schwebel's equity ownership interests in the following three joint ventures: - - a 43.6% share in CS-Interglas AG ("CS-Interglas") headquartered in Germany, together with fixed-price options to increase this equity interest to 84.0%. Hexcel's acquisition of the CS-Interglas equity interest and related options was completed on December 23, 1998; - - a 43.3% share in Asahi-Schwebel Co., Ltd. ("Asahi-Schwebel"), headquartered in Japan, which in turn has its own joint venture with AlliedSignal Inc. in Taiwan; and - - a 50.0% share in Clark-Schwebel Tech-Fab Company ("CS Tech-Fab"), headquartered in the United States. CS-Interglas and Asahi-Schwebel are fiberglass fabric producers serving the European and Asian electronics and telecommunications industries. CS Tech-Fab manufactures non-woven materials for roofing, construction and other specialty applications. The fixed-price options to increase the equity interest in CS-Interglas are, in the Company's opinion, significantly higher than their current fair market value. Accordingly, the Company does not currently anticipate exercising the options, at the stated price, before their expiration on December 31, 1999. The unconsolidated revenues in 1998 for these joint ventures were in excess of $300 million. The acquisition of the Acquired Clark-Schwebel Business was completed pursuant to an Asset Purchase Agreement dated July 25, 1998, as amended, by and among Hexcel, Stamford CS Acquisition Corp., and Clark-Schwebel (the "Asset Purchase Agreement"). Under the Asset Purchase Agreement, Hexcel acquired the net assets of the acquired business, other than certain excluded assets and liabilities, in exchange for approximately $472.8 million in cash. Hexcel also agreed to lease $50.0 million of property, plant and equipment used in the acquired business from an affiliate of Clark-Schwebel, pursuant to a long-term lease with purchase options. The acquisition of the Acquired Clark-Schwebel Business was accounted for under the purchase method of accounting. Accordingly, the consolidated balance sheets, statements of operations, and cash flows include the financial position, results of operations and cash flows of the acquired business as of such date and for such periods that the business was owned by Hexcel. Further discussions of the acquisition and its related financing are contained in Notes 2 and 4 to the accompanying condensed consolidated financial statements. RESULTS OF OPERATIONS NET SALES: Net sales for the first quarter of 1999 were $316.2 million, compared with $256.7 million for the first quarter of 1998 and $317.2 million for the first quarter of 1998 on a pro forma basis, after giving effect to the acquisition of the Acquired Clark-Schwebel Business as if the transaction had occurred at the beginning of 1998. Strong sales of composite products to the commercial aerospace and space and defense markets were offset by reduced sales of carbon fiber and sales to the electronics market. On a constant currency basis, first quarter 1999 net sales would not have been materially different than reported. 14
The following table summarizes net sales to third-party customers by product group and market segment for the quarter ended March 31, 1999 and pro forma net sales for the quarter ended March 31, 1998: <TABLE> - -------------------------------------------------------------------------------------------------------------------- UNAUDITED ------------------------------------------------------------------------------------ COMMERCIAL SPACE & GENERAL (IN MILLIONS) AEROSPACE DEFENSE ELECTRONICS INDUSTRIAL RECREATION TOTAL - -------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> FIRST QUARTER 1999 NET SALES Reinforcement products $ 11.7 $ 5.5 $ 42.3 $ 21.5 $ 4.8 $ 85.8 Composite materials 122.4 27.5 - 18.3 9.0 177.2 Engineered products 48.9 3.3 - 1.0 - 53.2 - -------------------------------------------------------------------------------------------------------------------- $ 183.0 36.3 42.3 40.8 13.8 316.2 Total 58% $ 11% $ 13% $ 13% $ 5% $ 100% - -------------------------------------------------------------------------------------------------------------------- PRO FORMA FIRST QUARTER 1998 NET SALES Reinforcement products $ 11.2 $ 7.2 $ 52.2 $ 26.8 $ 6.0 $ 103.4 Composite materials 118.8 21.4 - 13.3 10.6 164.1 Engineered products 46.1 2.8 - 0.8 - 49.7 - -------------------------------------------------------------------------------------------------------------------- $ 176.1 $ 31.4 $ 52.2 $ 40.9 $ 16.6 $ 317.2 Total 56% 10% 16% 13% 5% 100% - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- </TABLE> Commercial aerospace net sales increased 4% to $183.0 million for the first quarter of 1999, from $176.1 million on a pro forma basis for the first quarter of 1998. The growth in sales was largely attributable to increased sales of composite materials and reflects the increase in commercial aircraft build rates by the Company's two largest customers, The Boeing Company ("Boeing") and Airbus Industrie ("Airbus"). The increase also reflects an improvement in the engineered products segment's shipments of retrofit interiors to airline customers. Approximately 44% of Hexcel's pro forma full year 1998 net sales were to Boeing, Airbus and related subcontractors. Based on published projections, combined deliveries for Boeing and Airbus were 577 and 788 in 1997 and 1998, respectively, and are expected to peak at 913 in 1999, before declining to approximately 800 in 2000. The Company sells material for every model of commercial aircraft sold by Boeing and Airbus, with sales per aircraft ranging from $0.1 million to over $1.0 million. Depending on the product, orders placed with Hexcel are received anywhere between one and eighteen months prior to delivery of the aircraft to the customer. As the Company supplies its products ahead of the delivery of a commercial aircraft, it will start to see the impact of reduced Boeing production rates by summer 1999. During 1998, the Company's commercial aerospace customers started emphasizing the need for material yield improvement and cost and inventory reduction throughout the industry's supply chain. In response to these pressures, the Company reduced the price of certain products in 1999. Further, the Company is aware that in the third quarter of 1999, one customer is planning to substitute one of Hexcel's premium products for a lower cost, lower priced alternative product, which will also be provided by Hexcel. Although these changes impact the Company's profit margins, the Company's various cost reduction and efficiency improvement programs are focused on mitigating the impact in whole or in part. Meanwhile, the Company's sales of products used to retrofit aircraft interiors continue to grow, with a strong initial reception for its kit product that extends the size of overhead stowage bins in narrow aisle aircraft. Space and defense net sales for the first quarter of 1999 increased 16% to $36.3 million, from $31.4 million on a pro forma basis for the first quarter of 1998, primarily reflecting an increase in sales of composite materials to select military and space programs. 15
In the last quarter of 1998, the Company experienced cancellations of certain carbon fiber orders. The Company believes that, in response to a significant shortage of carbon fiber supply in 1997, a number of the Company's customers, particularly those in the space and defense market, purchased and/or ordered more carbon fiber than they needed during 1997 and 1998. Now that carbon fiber supplies are more certain, customers are reducing their inventories and are therefore anticipating lower purchasing needs for 1999. These factors resulted in surplus inventories throughout the supply chain, including Hexcel, at December 31, 1998 and a significant reduction in the anticipated carbon fiber production for 1999 as compared to 1998. The increase in worldwide carbon fiber capacity limits both the Company's ability to sell its short-term excess capacity to other markets and prices at which such surplus capacity can be sold. Electronics net sales decreased 19% to $42.3 million for the first quarter of 1999, from $52.2 million on a pro forma basis for the first quarter of 1998. The reduction in sales primarily reflects the impact of price reductions combined with lower unit sales volume in the United States. During the quarter, intense competition from manufacturers located in Asia continued to place pressure on the prices of the Company's electronic fiberglass products. The Company has been successful in partially offsetting these price reductions by obtaining lower raw material prices. In addition the Company continues to seek opportunities to reduce the cost of its products and during the quarter announced the closure of its Cleveland, Georgia plant as a targeted cost reduction action. General industrial net sales for the first quarter of 1999 were comparable to pro forma first quarter 1998. Recreation net sales decreased 17% in the first quarter of 1999 compared to first quarter 1998 net sales on a pro forma basis, reflecting reduced customer demand for certain products in this market, including, one particular customer who is changing the design of many of its athletic shoes to alternative materials. BACKLOG: The backlog of commercial aerospace and space and defense orders scheduled for delivery in the next 12 months was as follows: <TABLE> --------------------------------------------------------------------------------------------------------------- UNAUDITED ------------------------------------------------------------- Commercial Space and (IN MILLIONS) Aerospace Defense Total --------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> AS OF MARCH 31, 1999 Reinforcement products $ 12.7 $ 15.3 $ 28.0 Composite materials 194.0 42.1 236.1 Engineered products 145.5 10.9 156.4 --------------------------------------------------------------------------------------------------------------- Total $ 352.2 $ 68.3 $ 420.5 --------------------------------------------------------------------------------------------------------------- AS OF DECEMBER 31, 1998 Reinforcement products $ 5.9 $ 6.5 $ 12.4 Composite materials 226.9 40.1 267.0 Engineered products 165.1 7.6 172.7 --------------------------------------------------------------------------------------------------------------- Total $ 397.9 $ 54.2 $ 452.1 --------------------------------------------------------------------------------------------------------------- AS OF MARCH 31, 1998 Reinforcement products $ 10.4 $ 20.0 $ 30.4 Composite materials 237.3 57.2 294.5 Engineered products 158.6 9.9 168.5 --------------------------------------------------------------------------------------------------------------- Total $ 406.3 $ 87.1 $ 493.4 --------------------------------------------------------------------------------------------------------------- </TABLE> The decrease in the Company's backlog is attributable to commercial aerospace build rates, which are 16
expected to peak in 1999 and the continuing trend towards shorter lead times and better supply-chain management by the industry overall. Because the Company supplies its products ahead of the delivery of a commercial aircraft, it will start to see the impact of the lower anticipated deliveries of Boeing aircraft in 2000 by the second half of 1999. Backlog for the Company's other markets is not a material trend indicator and accordingly, such amounts are not presented. GROSS MARGIN: Gross margin for the first quarter of 1999 was $70.8 million, or 22.4% of net sales, compared with $66.1 million, or 25.7% of net sales, for the first quarter of 1998. The decrease is attributable to a number of factors, including a reduction in pricing, and to a lesser extent, sales volume, in the global electronics market due to the competitive conditions, lower production and sales of carbon fiber products, and supply chain pressures in the commercial aerospace market. These factors were partially offset by lower material costs. The Company is pursuing efforts to reduce its cost structure and increase its productivity through its Lean Enterprise program, which was extended to all U.S. locations in the latter part of 1998 and which will be extended to its European facilities in 1999. The expected improvements in cost and productivity will be offset by customer demand for reductions in the costs of the products that they purchase from the Company. OPERATING INCOME: Operating income was $27.2 million in the first quarter of 1999, or 8.6% of net sales, compared with $33.7 million in the first quarter of 1998, or 13.1% of net sales. Excluding business acquisition and consolidation expenses, operating income was $30.0 million, or 9.5% of net sales. The aggregate decrease in operating income, excluding business acquisition and consolidation expenses, reflects the decrease in gross margins and increased selling, general and administrative ("SG&A") and research and technology ("R&T") expenses over the first quarter 1998. SG&A expenses were $34.3 million, or 10.9% of net sales for the first quarter of 1999 compared with $27.2 million, or 10.6% of net sales for the first quarter of 1998. The aggregate dollar increase in SG&A was primarily attributable to the Acquired Clark-Schwebel Business and costs associated with the implementation of the Company's Lean Enterprise and supply-chain initiatives. R&T expenses were $6.5 million, or 2.1% of net sales for the first quarter of 1999 compared with $5.2 million, or 2.0% of net sales for the first quarter of 1998. EQUITY IN LOSSES OF AFFILIATED COMPANIES: As part of the Acquired Clark-Schwebel Business, the Company acquired interests in three joint ventures. Competitive conditions in the electronics market, resulting from the Asian economic situation, impacted the performance of two of these joint ventures during the first quarter of 1999. As a result, the Company recognized a nominal amount of equity in losses of affiliated companies in the first quarter of 1999. NET INCOME AND NET INCOME PER SHARE: Net income for the first quarter of 1999 was $5.2 million, or $0.14 per diluted share, compared with net income for the first quarter of 1998 of $17.1 million, or $0.40 per diluted share. Excluding business acquisition and consolidation expenses of $2.8 million, first quarter 1999 net income would have been $0.19 per diluted share. Pro forma first quarter 1998 diluted net income per share, after giving effect to the acquisition of the Acquired Clark-Schwebel Business as if the transaction had occurred at the beginning of 1998, was $0.43 per diluted share. There were 36.5 million diluted weighted-average shares outstanding during the first quarter of 1999, versus 46.3 million during the first quarter of 1998. The quarter-over-quarter decrease in the number of weighted average shares is primarily attributable to the exclusion of 8.1 million of potential common shares relating to the Convertible Subordinated Notes, due 2003, and the Convertible Subordinated Debentures, due 2011, which were antidilutive in the 1999 period. Refer to Note 6 to the accompanying condensed consolidated financial statements for the calculation and the number of shares used for diluted net income per share. 17
FINANCIAL CONDITION AND LIQUIDITY SENIOR CREDIT FACILITY In connection with the acquisition of the Acquired Clark-Schwebel Business on September 15, 1998, Hexcel obtained a new global credit facility (the "Senior Credit Facility") to: (a) fund the purchase of the Acquired Clark-Schwebel Business; (b) refinance the Company's existing revolving credit facility; and (c) provide for ongoing working capital and other financing requirements of the Company. Simultaneously with the January 1999 closing of the $240.0 million principal amount of 9.75% senior subordinated notes due 2009 (the "Senior Subordinated Notes") offering, the Company amended the Senior Credit Facility to, among other things, reduce the available borrowing capacity from $910.0 million to $672.0 million, modify certain financial covenants and to permit the offering. Approximately $544 million of the Senior Credit Facility expires in September 2004, with the balance expiring in 2005. The Company expects that its financial resources, including the Senior Credit Facility, will be sufficient to fund the Company's worldwide operations for the foreseeable future. Nonetheless, one of the Company's primary goals over the next few years is generating operating cash flow to reduce debt. Further discussion of the Company's financial resources is contained in Note 4 to the accompanying condensed consolidated financial statements. SENIOR SUBORDINATED NOTES DUE 2009 On January 21, 1999, the Company issued $240.0 million of Senior Subordinated Notes due 2009. The Senior Subordinated Notes are general unsecured obligations of Hexcel that bear interest at a rate of 9.75% per annum. Net proceeds of approximately $231 million from this offering were used to repay amounts owed under the Senior Credit Facility. The Senior Subordinated Notes are redeemable beginning in January of 2004, in whole or in part, at the option of Hexcel. The redemption prices range from 104.9% to 100.0% of the outstanding principal amount, depending on the period in which redemption occurs. SENIOR SUBORDINATED NOTE PAYABLE TO A RELATED PARTY The senior subordinated note payable to a related party, is payable to Ciba Specialty Chemicals Inc., and is a general unsecured obligation of Hexcel. Ciba Specialty Chemicals Inc. and its affiliate, Ciba Specialty Chemicals Corporation, collectively hold approximately 49.6% of the Company's common stock. From February 28, 1996 through February 28, 1999, the senior subordinated note payable to a related party bore interest at a rate of 7.5% per annum. On February 28, 1999, the interest rate increased to 10.5% per annum, and will continue to increase by an additional 0.5% per year thereafter until they mature in 2003. On February 17, 1999, the Company redeemed $12.5 million of the note payable, with such repayment financed with borrowings under the Company's Senior Credit Facility. CAPITAL EXPENDITURES Capital expenditures totaled $9.4 million for the first three months of 1999 compared to $11.5 million for the first three months of 1998 and $12.5 million for the first three months of 1998 on a pro forma basis. The decrease reflects reduced spending due to changing market conditions, the expected benefits from the Company's Lean Enterprise program and a commitment to reduce debt. ADJUSTED EBITDA, CASH FLOWS AND RATIO OF EARNINGS TO FIXED CHARGES FIRST QUARTER, 1999: Earnings before business acquisition and consolidation expenses, other income, interest, taxes, depreciation and amortization, and equity in earnings of affiliated companies ("Adjusted EBITDA") was $45.6 million. Net cash provided by operating activities was $17.3 million, as $5.2 18
million of net income and $15.7 million of non-cash depreciation and amortization more than offset cash used by all other operating activities. Net cash used for investing activities was $9.4 million, reflecting the Company's capital expenditures for the quarter. Net cash used for financing activities was $12.4 million, primarily reflecting $9.0 million of debt issuance costs pertaining to the issuance of the Senior Subordinated Notes. FIRST QUARTER, 1998: Adjusted EBITDA was $43.7 million. Pro forma Adjusted EBITDA, after giving effect to the acquisition of the Acquired Clark-Schwebel Business as if the transaction had occurred at the beginning of 1998, was $57.5 million. Net cash used for operating activities was $5.1 million, as increased working capital of $26.7 million and restructuring payments of $1.8 million more than offset $17.1 million of net income and $6.3 million of non-cash depreciation and amortization and deferred income taxes. The increase in working capital reflected higher levels of accounts receivable and inventory, as well as reductions in accrued liabilities from peak year-end levels, primarily due to the payment of obligations paid in 1998 for capital projects and employee incentive and benefit programs incurred during 1997. Net cash used for investing activities was $12.3 million, reflecting $11.5 million of capital expenditures. Net cash provided from financing activities, which primarily included borrowings under the Company's previous credit facility, totaled $11.0 million. Adjusted EBITDA and pro forma Adjusted EBITDA have been presented to provide a measure of Hexcel's operating performance that is commonly used by investors and financial analysts to analyze and compare companies. Adjusted EBITDA may not be comparable to similarly titled financial measures of other companies. Adjusted EBITDA and pro forma Adjusted EBITDA do not represent alternative measures of the Company's cash flows or operating income, and should not be considered in isolation or as substitutes for measures of performance presented in accordance with generally accepted accounting principles. 19
Reconciliations of net income to EBITDA and Adjusted EBITDA for the quarters ended March 31, 1999 and 1998, including pro forma first quarter 1998, after giving effect to the acquisition of the Acquired Clark-Schwebel Business as if it occurred at the beginning of 1998, are as follows: <TABLE> - --------------------------------------------------------------------------------------------------------------------- PRO FORMA FIRST FIRST QUARTER FIRST QUARTER QUARTER (IN MILLIONS) 1999 1998 1998 - --------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> Net income $ 5.2 $ 18.2 $ 17.1 Provision for income taxes 2.8 9.4 9.6 Interest expense 19.1 16.4 7.0 Depreciation and amortization expense 15.7 15.1 10.0 Equity in earnings of affiliated companies - (1.6) - - --------------------------------------------------------------------------------------------------------------------- EBITDA 42.8 57.5 43.7 Business acquisition and consolidation expenses 2.8 - - - --------------------------------------------------------------------------------------------------------------------- Adjusted EBITDA $ 45.6 $ 57.5 $ 43.7 - --------------------------------------------------------------------------------------------------------------------- </TABLE> The ratio of earnings to fixed charges for the quarters ended March 31, 1999 and 1998, and pro forma first quarter 1998, were 1.4x, 4.6x and 2.6x, respectively. The decrease in the ratio in the first quarter of 1999 reflects the Company's lower operating income and higher interest costs. The calculation of earnings to fixed charges assumes that one-third of the Company's rental expense is attributable to interest expense. BUSINESS CONSOLIDATION Over the past few years, the Company has announced two major business consolidation programs. The first one was announced in May 1996 and later revised in December 1996 (the "1996 program"), and primarily related to the integration of the acquired composite business of Ciba-Geigy Ltd. and the acquired carbon fibers and prepreg business of Hercules Inc. In December 1998 and March 1999, the Company announced a second program related to the integration of the Acquired Clark-Schwebel business and the combination of the Company's U.S., European and Pacific Rim composite materials businesses into a single, global business unit (the "1998/1999 program"). More detailed discussions on each of these programs are set forth below. Total accrued business acquisition and consolidation expenses at December 31, 1998 and March 31, 1999, and activity during the quarter ended March 31, 1999 for each of these programs was as follows: <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------- 1998/1999 1996 PROGRAM (IN THOUSANDS) PROGRAM TOTAL - ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> BALANCE AS OF DECEMBER 31, 1998 $ 5,002 $ 3,200 $ 8,202 Business acquisition and consolidation expenses 2,809 - 2,809 Cash expenditures (2,242) - (2,242) Non-cash usage, including asset write-downs and currency translation effects (1,927) (100) (2,027) - ----------------------------------------------------------------------------------------------- BALANCE AS OF MARCH 31, 1999 $ 3,642 $ 3,100 $ 6,742 - ----------------------------------------------------------------------------------------------- </TABLE> 1998/1999 PROGRAM In December 1998, Hexcel announced business consolidation actions within its reinforcement products and composite materials businesses. These actions included the integration of Hexcel's existing fabrics business with the U.S. operations of the Acquired Clark-Schwebel Business, and the combination of the Company's U.S., European and Pacific Rim composite materials businesses into a single, global business unit. The objectives of these actions were to eliminate redundancies, improve manufacturing planning, and enhance customer service. As of March 31, 1999, the Company had substantially completed these business consolidation actions and to date, these actions have resulted in the elimination of approximately 100 operating, sales, marketing and administrative positions. Estimated savings from these actions, which the Company has already begun to realize, are expected to approximate $10 million per year. On March 16, 1999, the Company expanded its actions relating to the integration of the Acquired Clark-Schwebel Business with the announcement of the closure of its Cleveland, Georgia manufacturing facility by August 1999. This facility, which was part of the Acquired Clark-Schwebel Business, employs approximately 100 people and produces fabrics used to make laminate for printed circuit boards. Certain production equipment from the Cleveland, Georgia facility will be moved to the Company's Anderson, South Carolina facility. Closure of this facility resulted from current competitive conditions in the global market for electronic fiberglass materials and was not expected at the time of the acquisition of the Acquired Clark-Schwebel Business. Accrued business acquisition and consolidation expenses at December 31, 1998 and March 31, 1999, and activity during the quarter ended March 31, 1999 for the 1998/1999 program, were as follows (in thousands): 20
<TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------- EMPLOYEE FACILITY & SEVERANCE & EQUIPMENT 1998/1999 PROGRAM RELOCATION RELOCATION TOTAL - ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> BALANCE AS OF DECEMBER 31, 1998 $ 3,020 $ 1,982 $ 5,002 Business acquisition and consolidation expenses 994 1,815 2,809 Cash expenditures (1,497) (745) (2,242) Non-cash usage, including asset write-downs and currency translation effects - (1,927) (1,927) - ----------------------------------------------------------------------------------------------- BALANCE AS OF MARCH 31, 1999 $ 2,517 $ 1,125 $ 3,642 - ----------------------------------------------------------------------------------------------- </TABLE> As of December 31, 1998, accrued business consolidation and acquisition expenses for the 1998/1999 program primarily consisted of severance for employees terminated in December 1998, costs for early termination for certain leases, and equipment relocation costs incurred, but not yet paid. The Company's policy is to pay severance over a period of time rather than in a lump-sum amount. During the first quarter of 1999, the Company recorded additional business acquisition and consolidation expenses of $2.8 million, primarily reflecting the costs of closing the Cleveland, Georgia facility, of which $1.8 million represented a non-cash write-down on equipment that will be disposed of. The Company expects to record an additional charge of slightly above $1 million during the second and third quarters of 1999 relating to the relocation of certain equipment from the Cleveland, Georgia facility to the Company's Anderson, South Carolina facility. Cash expenditures during the quarter ended March 31, 1999 for the 1998/1999 program principally related to severance payments made to those employees terminated in December 1998. As of March 31, 1999, remaining accrued expenses for the 1998/1999 program primarily reflected severance and relocation costs for employees in the Company's Cleveland, Georgia facility and for employees terminated in December 1998, as well as costs relating to the early termination of certain leases. Remaining cash expenditures for the 1998/1999 program are expected to be funded through operating cash flows. The 1998/1999 program is expected to be substantially completed by the end of 1999. Anticipated cash savings from this business consolidation activity are expected to help offset competitive pricing pressures in the Company's electronics market. In addition to the Cleveland, Georgia facility closure, the Company is continuing to conduct a global capacity review. This review may result in the closing or right-sizing of additional facilities and, as a result, additional consolidation charges may be recognized in 1999. 1996 PROGRAM In 1996, Hexcel announced plans to consolidate the Company's operations over a period of three years. The objective of the program was to integrate acquired assets and operations into Hexcel, and to reorganize the Company's manufacturing and research activities around strategic centers dedicated to select product technologies. Management expected that this consolidation program would take approximately three years to complete, in part because of the aerospace industry requirements to "qualify" specific equipment and manufacturing facilities for the manufacture of certain products. These qualification requirements increase the complexity, cost and time of moving equipment and consolidating manufacturing activities. The program is near completion, and the Company expects that all activities related to this consolidation program will be finished by mid-1999. Accrued business acquisition and consolidation expenses at December 31, 1998 and March 31, 1999, and activity during the quarter ended March 31, 1999 for this business acquisition and consolidation program, were as follows (in thousands): <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------- EMPLOYEE FACILITY & SEVERANCE & EQUIPMENT 1996 PROGRAM RELOCATION RELOCATION TOTAL - ----------------------------------------------------------------------------------------------- <S> <C> <C> <C> BALANCE AS OF DECEMBER 31, 1998 $ 2,848 $ 352 $ 3,200 Non-cash usage, including asset write-downs and currency translation effects (100) - (100) - ----------------------------------------------------------------------------------------------- BALANCE AS OF MARCH 31, 1999 $ 2,748 $ 352 $ 3,100 - ----------------------------------------------------------------------------------------------- </TABLE> As of December 31, 1998 and March 31, 1999, accrued business acquisition and consolidation expenses for the 1996 program related to a $0.6 million foreign government grant received by the Company that is required to be repaid over a five year period due to lower employee levels as a result of the consolidation program, $2.1 million in employee retirement costs associated with terminations and $0.4 million of environmental costs related to a closed facility. The employee retirement costs are expected to be disbursed by mid-1999. The Company does not anticipate any additional expenses in relation to the 1996 program. 21
YEAR 2000 READINESS DISCLOSURE Hexcel, like most other companies, is continuing to address whether its information technology systems and non-information technology devices with embedded microprocessors (collectively "Business Systems and Devices") will recognize and process dates starting with the year 2000 and beyond (the "Year 2000"). The Year 2000 issue can arise at any point in the Company's supply, manufacturing, processing and distribution chains. The Company does not, however, manufacture or sell products that contain microprocessors or software. In early 1998, the Company established a central Year 2000 project office to coordinate and monitor progress towards achieving corporate-wide Year 2000 compliance. A discussion of the Company's Business Systems and Devices, suppliers and vendors as they pertain to the Company's Year 2000 issues, as of April 30, 1999, is detailed as follows: BUSINESS SYSTEMS & DEVICES In order to address the Year 2000 issue as it relates to the Company's Business Systems and Devices, the Company has developed, and is in the process of implementing, a six phase plan. The Company is also using external consulting services, where appropriate, as part of its efforts to address its Year 2000 issue. In implementing this plan, the Company has been, and continues to be substantially on schedule. The components of this plan and their related status, as of April 30, 1999, are detailed below and apply to both the Company's Business Systems and its Devices: (1) INVENTORY: This phase, which was completed in December 1998, consisted of compiling a detailed listing of the Company's Business Systems and Devices likely to be impacted by the Year 2000 issue. (2) RISK ASSESSMENT AND ASSIGNING PRIORITIES: This phase consisted of assessing the likelihood that a Business System or Device is not Year 2000 compliant as well as assigning a priority of importance to the particular Business System or Device as it relates to the Company's business operations. This phase was completed in December 1998. (3) ASSESSING COMPLIANCE: This phase consisted of assessing Year 2000 compliance on the Company's Business Systems or Devices which have been identified as essential to the Company's business operations. In assessing compliance, the Company performs a variety of tasks including, obtaining Year 2000 compliance statements and information from the Company's vendors and service providers. This phase was completed in March 1999. However, the Company is dependent upon 22
its suppliers and service providers to continue to inform Hexcel as to any updates or changes to the information supplied to Hexcel. (4) REPAIRING OR REPLACING: This phase consists of repairing and replacing non-Year 2000 compliant Business Systems and Devices which are essential to the Company's operations. This phase is approximately 70% complete, with substantial completion estimated by June 30, 1999. (5) TESTING: This phase consists of testing the repair or replacement of those Business Systems and Devices, which are essential to the Company's business operations. The Company also intends to test the integration of the various Business Systems and Devices within the Company's manufacturing processes. This phase is approximately 55% complete, with substantial completion estimated by June 30, 1999. The results of this phase may change the estimated timing of completion of phase four. (6) DEVELOPING CONTINGENCY PLANS: This phase consists of developing alternative plans in the event that a business interruption occurs from a Year 2000 issue. The Company is in the early stages of this phase. The Company has targeted September 30, 1999 as the date for substantial completion of its contingency plans, however, the Company believes that this phase will be on-going through to the year 2000. SUPPLIERS & CUSTOMERS The Company is also gathering information from its significant suppliers and customers concerning their Year 2000 issues as a means of assessing risks and developing alternatives. The Company has sent out surveys to all of its significant suppliers and customers to determine what steps, if any, those companies are taking to remediate their respective Year 2000 issues. The Company is, however, dependent upon its suppliers and customers with respect to the completeness and accuracy of such responses. As of April 30, 1999, the Company has received responses from nearly two-thirds of its significant suppliers and one-third of its significant customers. The responses from the Company's suppliers generally indicate that these parties are taking actions to ensure that their ability to supply products or services to the Company will not be impaired. To the extent that supplier responses to Year 2000 readiness are unsatisfactory, the Company will attempt to reduce risks of interruptions, with such options including changes in suppliers to those who have demonstrated Year 2000 readiness, and accumulation of inventory. The responses from the Company's customers also generally indicate that these parties are taking actions to ensure their ability to purchase products from the Company will not be impaired. The Company will continue to monitor the status of all of its significant suppliers' and customers' Year 2000 readiness through to the year 2000, in order to determine whether additional or alternative measures are necessary. Total estimated costs to address the Company's Year 2000 issues, including preparing the Company's Business Systems and Devices to become Year 2000 compliant, is approximately $5 million, of which approximately $1.5 million has been incurred through March 31, 1999. The total estimated costs includes approximately $2 million of capital expenditures to be used for the purchase of certain capital equipment to replace equipment which is currently not Year 2000 compliant. The estimate also includes the cost of certain internal resources fully dedicated to this project, however, the estimate does not include any costs associated with the implementation of contingency plans, which have not yet been developed. The Company has not used any external resources to independently verify these cost estimates. Due to resource constraints caused by the Year 2000 issue, the Company is deferring other information technology projects. These deferrals, however, are not expected to have a material adverse effect on the Company's results of operations or financial condition. 23
The Company is progressing with the development of its Year 2000 contingency plans. These plans are expected to be substantially completed by September 30, 1999. The Company is currently unable to assess the most reasonably likely worst case scenarios. However, if necessary remediation actions are not completed in a timely manner, or if the Company's suppliers and customers do not successfully address their Year 2000 issues, the Company estimates that a disruption in operations could occur. Such a disruption could result in, for example, delays in the receipt of raw materials and distribution of finished goods, or errors in customer orders. These consequences could have a material impact on the operations, liquidity and financial condition of the Company. The Company presently believes that by implementing its plans, including modifications to existing Business Systems and Devices and conversion to new or upgraded software and other systems, the Year 2000 issue will not pose significant operational problems for the Company. RECENTLY ISSUED ACCOUNTING STANDARD In June 1998, the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). This Statement requires companies to record derivatives on the balance sheet as assets and liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS 133 is not expected to have a material impact on Hexcel's consolidated financial statements. This Statement is effective for fiscal years beginning after June 15, 1999. Hexcel will adopt this accounting standard as required by January 1, 2000. FORWARD-LOOKING STATEMENTS AND RISK FACTORS Certain statements contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations," that are not of historical fact, constitute "forward-looking statements". Such forward-looking statements include, but are not limited to: (a) estimates of commercial aerospace production and delivery rates, including those of Boeing and Airbus; (b) estimates of the change in net sales in total and by market compared to pro forma 1998 net sales; (c) expectations regarding the impact of pricing pressures from Hexcel's customers; (d) expectations regarding the ability of Hexcel to pass along price reductions to its suppliers; (e) expectations regarding future sales based on current backlog; (f) expectations regarding sales growth, sales mix, gross margins, manufacturing productivity and capital expenditures; (g) expectations regarding Hexcel's financial condition and liquidity, as well as future free cash flows and earnings; (h) estimated additional business acquisition and consolidation expenses to be incurred in 1999; (i) expectations regarding the costs and benefits of Hexcel's Lean Enterprise and business consolidation programs, including the closure of the Company's Cleveland, GA facility and implementation of a supply-chain management program; (j) expectations regarding the exercise of the CS-Interglas options at their stated price; and; (k) the impact of the Year 2000 issue, the estimated costs associated with becoming Year 2000 compliant and the estimated target date for substantial completion of remediation. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different. Such factors include, but are not limited to, the following: the integration of the Acquired Clark-Schwebel Business without disruption to manufacturing, marketing and distribution activities; changes in general economic and business conditions; changes in current pricing levels; changes in political, social and economic conditions and local regulations, particularly in Asia and Europe; foreign currency fluctuations; changes in aerospace delivery rates; 24
reductions in sales to any significant customers, particularly Boeing or Airbus; changes in sales mix; changes in government defense procurement budgets; changes in military aerospace programs technology; industry capacity; competition; disruptions of established supply channels; manufacturing capacity constraints; the availability, terms and deployment of capital; and the ability of Hexcel to accurately estimate the cost of systems preparation and successfully implement required actions for Year 2000 compliance. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different. Additional information regarding these factors is contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. 25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK A discussion of market risk exposures is included in Part II, Item 7A, of Hexcel's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. There has been no material change to this information during the three months ended March 31, 1999. 26
PART II. OTHER INFORMATION HEXCEL CORPORATION AND SUBSIDIARIES ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: <TABLE> <S> <C> 1.1 Form of Employee Option Agreement (1999). 1.2 Form of Performance Accelerated Restricted Stock Unit Agreement (1999) 1.3 Form of Grant of Restricted Stock Unit Agreement (1999). 1.4 Split Dollar Agreement dated as of January 21, 1999 among Hexcel, John J. Lee and certain Trustees. 10.5 Executive Severance Agreement between Hexcel and John J. Lee dated as of February 3, 1999. 10.6 Form of Executive Severance Agreement between Hexcel and certain executive officers dated as of February 3, 1999. 10.7 Form of Executive Severance Agreement between Hexcel and certain executive officers dated as of February 3, 1999. 27. Financial Data Schedule. </TABLE> (b) REPORTS ON FORM 8-K: Report dated January 5, 1999, relating to the proposed issuance of $275 million of senior subordinated notes due 2009 pursuant to Rule 144A. Report dated January 25, 1999, relating to the Company's fourth quarter and full-year 1998 financial results. Report dated March 17, 1999, relating to the closure of the Company's Cleveland, Georgia facility. Report dated March 29, 1999, relating to the Company's first quarter 1999 outlook. Report dated April 30, 1999, relating to the Company's pro forma and actual business segment data and net sales to third-party customers by product group, for each of the quarters ended March 31, June 30, September 30 and December 31, 1998, and for the year ended December 31, 1998. 27
SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, and in the capacity indicated. HEXCEL CORPORATION (Registrant) May 14, 1999 /s/ Wayne C. Pensky - ------------------------------- ------------------------------- (Date) Wayne C. Pensky, Vice President; Corporate Controller; and Chief Accounting Officer 28