HXL

Business Context and Reporting Period

Company: Hexcel Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 1998
Business Overview: Hexcel manufactures advanced composite materials and engineered products primarily for the commercial aerospace, space and defense, recreation, and general industrial markets. The company is a major supplier to Boeing and Airbus.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 13.2% in Q2 1998 and 16.4% YTD compared to 1997. Growth was driven by strong demand in commercial aerospace (up 25% in Q2) and space/defense markets.
• Margin Expansion: Gross margin percentage improved to a record 26.0% in Q2 1998 from 23.9% in Q2 1997, attributed to higher volume, manufacturing productivity, and carbon fiber capacity expansion.
• Profitability: Operating income rose 56% in Q2 1998. This was aided by a $2.8 million reduction in business acquisition and consolidation expenses compared to the prior year.
• Tax Rate: The effective tax rate increased to 36% in 1998 from 19-20% in 1997. The 1997 rate was artificially low due to the utilization of loss carryforwards and the reversal of a deferred tax asset reserve.
• Cash Flow: Operating cash flow turned positive YTD 1998 ($22.8M) compared to a negative $30.8M in YTD 1997, despite a $38.2M increase in working capital requirements.

Guidance, Outlook, and Risks

Proposed Acquisition

On July 25, 1998, Hexcel agreed to acquire Clark-Schwebel, Inc. (C-S) for $453 million in cash, plus a $60 million capital lease for retained assets. The deal is expected to close in Q3 1998. C-S specializes in fiberglass fabrics for electronics and telecommunications. The acquisition aims to diversify revenue, increasing non-aerospace sales from 35% to approximately 50% on a pro-forma basis.

Financing

To fund the C-S acquisition and refinance existing debt, Hexcel secured a commitment for a new credit facility with up to $925 million in borrowing capacity.

Outlook and Risks

• Aerospace Demand: Management expects commercial aerospace delivery rates (Boeing/Airbus) to flatten, potentially leveling off sales growth in this segment.
• Market Weakness: Anticipated weaker demand in H2 1998 for products serving commercial satellites, athletic shoes, golf clubs, and printed circuit boards.
• Cost Reduction: The company is implementing "Lean Enterprise" initiatives to reduce costs and offset customer pressure for lower prices.
• Year 2000 Issue: The company is evaluating IT systems for Y2K compliance; costs are currently deemed immaterial, but failure to comply could materially impact operations.
• Stock Buyback: On August 5, 1998, the Board approved a plan to repurchase up to $10 million of common stock.

Investor Verification Checklist

• Acquisition Closing: Verify the successful completion of the Clark-Schwebel acquisition and the associated regulatory clearances.
• Financing Execution: Confirm the finalization of the new $925 million credit facility and the refinancing of the existing $355 million revolver.
• Aerospace Order Rates: Monitor Boeing and Airbus delivery schedules to validate the "leveling off" sales forecast.
• Margin Sustainability: Assess whether the record 26% gross margin can be maintained as aerospace growth slows and consolidation expenses cease.
• Working Capital: Review the trend in accounts receivable and inventory, which increased significantly in H1 1998, impacting operating cash flow.