HXL

Business Context and Reporting Period

Company: Hexcel Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2007
Business Overview: Hexcel manufactures advanced composite materials and engineered products. During the period, the company executed a strategic portfolio review, consolidating operations into two segments: Composite Materials and Engineered Products. Significant divestitures included the sale of the European Architectural business (completed Feb 2007) and the agreement to sell the EBGI (Electronics, Ballistics, and General Industrial) business (agreement signed June 2007).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 5.8% in Q2 and 7.1% YTD compared to the prior year, driven by growth in Commercial Aerospace and Space & Defense markets. On a constant currency basis, Q2 sales grew 3.0%.
• Discontinued Operations Impact: Total Net Income for Q2 2007 was significantly lower than Q2 2006 ($8.8M vs $17.6M) due to an $8.7M after-tax loss from discontinued operations. This loss primarily reflects a $9.7M charge related to the DOJ investigation into Zylon fiber ballistic vests.
• Divestitures: The company recognized a $6.8M after-tax gain on the sale of the European Architectural business in Q1 2007. The EBGI business is classified as discontinued operations pending sale.
• Margin Pressure: Gross margin percentage declined slightly in Q2 (24.3% vs 24.6%) due to unplanned equipment outages increasing maintenance and labor costs.
• Tax Rate: The effective tax rate increased to 42.5% in Q2 2007 (from 39.2% in 2006) due to the adoption of FIN 48 (Accounting for Uncertainty in Income Taxes).

Guidance, Outlook, and Risks

• EBGI Sale: The company signed a definitive agreement to sell the EBGI business for $62.5M plus up to $12.5M in earn-outs. Closing is expected in Q3 2007, with an anticipated after-tax loss of $2M-$3M upon completion.
• Portfolio Review Conclusion: Upon the EBGI sale, the portfolio review will conclude with total cash proceeds of approximately $110M and a net after-tax gain of $14M-$15M.
• Pension Plan Termination: The company plans to terminate its U.S. qualified pension plan. Final settlement is expected within 12 months, requiring a cash contribution of $10M-$12M and a pre-tax loss of approximately $13M.
• Legal Contingencies:
  • Zylon Matter: Anticipating a $15M settlement with the DOJ regarding defective Zylon fiber vests (no admission of wrongdoing).
  • Hercules Indemnity: Hercules Inc. is appealing a summary judgment dismissal regarding indemnification for antitrust settlements. Additional claims for $3.8M exist but are expected to be invalid if the judgment is affirmed.
  • Austrian Exotherm: Three employees face criminal charges for an environmental incident; the company is defending vigorously.
• Market Risks: Exposure to foreign currency fluctuations (Euro, British Pound) and interest rate changes on floating-rate debt. The company utilizes swaps and forward contracts to hedge these risks.

Investor Verification Checklist

• EBGI Transaction Timing: Verify the closing date of the EBGI sale in Q3 2007 and the final settlement amount.
• Zylon Settlement Approval: Confirm final DOJ approval of the $15M settlement and ensure no further debarment risks exist.
• Pension Plan Termination: Monitor regulatory approval for the U.S. pension plan termination and the timing of the $10M-$12M cash outflow.
• FIN 48 Impact: Assess the ongoing volatility in the effective tax rate due to the new accounting standard for uncertain tax positions.
• Airbus A380 Demand: Track recovery in A380 program sales, which remain at low levels and impact year-over-year comparisons.