HXL

Business Context and Reporting Period

This Form 10-Q covers Hexcel Corporation for the quarter and nine-month period ended September 29, 1996. The reporting period is defined by two major strategic acquisitions: the worldwide composites division of Ciba-Geigy (completed February 29, 1996) and the composite products division of Hercules Incorporated (completed June 27, 1996). These transactions significantly expanded Hexcel's footprint in aerospace, recreation, and industrial markets, necessitating a major business consolidation program to integrate operations.

Key Financial Metrics

Liquidity and Capital Structure: As of September 29, 1996, Hexcel held $4.2 million in cash and equivalents. Total debt obligations stood at $307.9 million, driven by a new $310 million Revolving Credit Facility (with ~$250 million availability after note issuance) and $114.5 million in Convertible Subordinated Notes issued in July 1996. The company also holds approximately $34.1 million in Senior Subordinated Notes payable to Ciba.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 133% year-over-year for the quarter and 87% year-over-year for the nine-month period. Excluding acquired businesses, organic sales grew 13% in Q3 and 12% YTD, driven by higher aerospace volumes and price increases.
• Profitability Impact: While Q3 operating income improved to $8.9M from $5.1M, the YTD period resulted in an operating loss of $1.9M compared to $13.7M income in 1995. This reversal is primarily due to $35.8 million in business consolidation and acquisition expenses recorded YTD 1996.
• Interest Expense: Interest expense surged to $7.2M in Q3 (from $2.3M) and $15.7M YTD (from $6.7M) due to debt financing the acquisitions and the write-off of $3.4M in capitalized debt financing costs.
• Share Count: Weighted average shares outstanding increased significantly (37.4M in Q3 1996 vs. 18.1M in Q3 1995) due to the issuance of approximately 18 million shares to Ciba as part of the acquisition consideration.

Guidance, Outlook, and Risks

Business Consolidation Program: Management announced a three-year consolidation plan with a total estimated expense of $49 million. Approximately $35.8 million has been recorded through Q3 1996. The program aims to eliminate excess capacity and redundant functions, targeting annual cost savings of approximately $28 million upon full implementation in 1999. Cash expenditures for the program are expected to total $44 million.

Outlook: Management expects capital expenditures to remain elevated in Q4 1996 to support consolidation and fiber capacity expansion. Financial resources are deemed sufficient to fund worldwide operations.

Risks and Contingencies:

• Integration Risk: Success depends on the seamless assimilation of Ciba and Hercules operations without disrupting manufacturing or marketing.
• Qualification Requirements: Aerospace industry requirements to "qualify" equipment and facilities may delay consolidation and increase costs.
• Debt Servicing: High leverage levels increase sensitivity to interest rate changes and cash flow volatility.
• Forward-Looking Assumptions: Cost savings estimates rely on assumptions regarding employee reductions, facility sales, and customer cooperation in requalifying products.

Investor Verification Checklist

• Acquisition Integration: Verify the progress of integrating Ciba and Hercules operations and whether the $28 million annual cost savings target remains achievable.
• Debt Covenants: Review the terms of the Revolving Credit Facility and Convertible Notes to ensure compliance with financial covenants given the current debt load.
• Consolidation Costs: Monitor the remaining $13.2 million of estimated consolidation expenses and the timing of future cash outflows.
• Working Capital: Assess the sustainability of the $29 million increase in accounts receivable and inventories relative to sales growth.
• Convertible Note Conversion: Track the stock price relative to the $15.81 conversion price of the $114.5 million Convertible Subordinated Notes.