HXL

Business Context and Reporting Period

This Form 10-Q covers Hexcel Corporation for the quarter ended March 31, 2003. Hexcel is a manufacturer of advanced composite materials and structures serving commercial aerospace, industrial, space and defense, and electronics markets. The reporting period is defined by a major capital structure refinancing completed on March 19, 2003, which resolved prior liquidity uncertainties and reclassified the majority of the company's debt from current to long-term.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 2.9% year-over-year, driven by improved defense sales and a 24% strengthening of the Euro against the U.S. dollar. Without currency effects, sales would have been $14.5 million lower.
• Margin Expansion: Gross margin improved to 20.1% from 17.8%, attributed to cost reduction programs and operational adjustments to lower production levels.
• Profitability: Operating income rose 29% to $17.2 million. The net loss narrowed significantly to $3.2 million from $9.2 million, aided by lower interest expense and reduced equity losses from affiliates.
• Capital Structure Refinancing: The company executed a comprehensive refinancing involving the issuance of $125 million in mandatorily redeemable convertible preferred stock and $125 million in 9.875% senior secured notes. Proceeds were used to redeem $46.9 million in subordinated notes and repay existing senior credit facilities.
• One-Time Charges: A $4.0 million loss on the early retirement of debt was recorded due to the write-off of unamortized financing costs associated with the refinancing.

Outlook, Risks, and Management Commentary

• Liquidity Position: Following the refinancing, management believes the company has adequate liquidity to finance operations beyond December 31, 2003. The company holds $13.1 million in cash and has $40.0 million in undrawn availability under its new $115 million senior secured credit facility.
• Segment Performance: Commercial aerospace sales leveled off but remain higher than Q4 2002 due to seasonality. Space and defense sales increased 14.8% year-over-year. Industrial sales remained flat, while electronics sales remained depressed but stable.
• Restructuring: Ongoing business consolidation and restructuring programs incurred $0.7 million in expenses for the quarter, with $8.4 million in remaining liabilities.
• Tax Implications: The issuance of preferred stock triggered an "ownership change" under IRC Section 382, limiting the annual utilization of U.S. net operating loss carryforwards to $5.3 million.
• Risks: Key risks include fluctuations in foreign currency exchange rates (particularly the Euro and British Pound), interest rate volatility on variable-rate debt, and dependence on major aerospace customers (Airbus and Boeing).

Investor Verification Checklist

• Debt Covenants: Verify compliance with the new financial maintenance covenants (leverage ratios and fixed charge coverage) under the March 2003 credit facility.
• Preferred Stock Terms: Review the conversion mechanics and dividend accretion of the Series A and Series B convertible preferred stock, noting the $3.00 conversion price and mandatory redemption date of January 22, 2010.
• Joint Venture Exposure: Assess the financial health of key joint ventures (BHA Aero, Asian Composites, TechFab) and the $11.1 million letter of credit supporting the BHA Aero loan.
• Working Capital Trends: Monitor the increase in accounts receivable and inventory, which contributed to a $25.4 million negative impact on operating cash flow from working capital changes.
• Ownership Change Impact: Confirm the long-term impact of the Section 382 limitation on the company's ability to utilize its $92.3 million in U.S. net operating loss carryforwards.