HXL

Business Context and Reporting Period

Company: Hexcel Corporation
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Quarter and six months ended June 30, 2002
Business Overview: Hexcel manufactures advanced composite materials and structural components for aerospace, defense, electronics, and industrial markets. The company is currently executing a restructuring program to reduce costs in response to declining commercial aircraft build rates and a downturn in the global electronics industry.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 12.7% in Q2 2002 and 16.3% year-to-date compared to 2001. This was driven by a 27.2% drop in commercial aerospace sales (due to reduced Boeing/Airbus build rates) and a 12.1% drop in electronics sales.
• Profitability Improvement: Despite lower sales, Operating Income increased 71% in Q2 2002 ($19.5M vs $11.4M). This was primarily due to significant SG&A reductions from restructuring and a one-time litigation gain.
• Litigation Gain: The company recognized a $9.8 million gain in Q2 2002 from a contract dispute settlement with Hercules, Inc., which was a major factor in turning a net loss in Q2 2001 into a net profit in Q2 2002.
• Investment Write-down: A $4.0 million non-cash impairment was recorded on an investment in an Asian electronics joint venture (Asahi-Schwebel Co. Ltd.) following a restructuring of the partnership.
• Accounting Changes: Adoption of FAS 142 eliminated goodwill amortization, improving reported earnings compared to 2001 which included $3.2M in amortization for the quarter.

Guidance, Outlook, and Risks

• Market Outlook: Management expects commercial aerospace revenues to decline 25-30% in 2002 compared to 2001. Electronics revenues are expected to remain weak with no substantial recovery anticipated in Q3 2002. Space & Defense and Industrial markets are expected to show growth.
• Restructuring: The company reduced its workforce by 745 employees (approx. 15%) in the first half of 2002 and plans to reduce headcount further to under 4,500 by year-end. Approximately $20.0 million in restructuring payments remain to be made.
• Liquidity and Covenants: The company is currently in compliance with its Senior Credit Facility covenants. However, the credit agreement was amended in January 2002 with stricter terms. Management states that substantial improvement in financial performance or debt reduction will be required to comply with covenants effective March 31, 2003, likely necessitating a further amendment.
• Debt Maturities: A significant debt maturity of $46.9 million (7% Convertible Subordinated Notes) is due in August 2003. The company is evaluating refinancing options but notes no assurance of obtaining favorable terms.
• Capital Expenditures: CapEx is capped at $25.0 million for 2002 under the credit facility amendment.

Investor Verification Checklist

• Covenant Compliance: Verify the company's ability to meet the stricter financial covenants (leverage and interest coverage ratios) required starting in Q1 2003.
• Refinancing Risk: Assess the feasibility of refinancing the $46.9 million convertible note maturing in August 2003 given current market conditions.
• Non-Recurring Items: Adjust financial analysis to exclude the $9.8 million litigation gain and the $4.0 million investment write-down to understand core operating performance.
• Restructuring Execution: Monitor the timing and cost of remaining restructuring payments ($20.0M estimated) and the impact on future cash flows.
• Aerospace Demand: Track Boeing and Airbus production rate announcements, as these are the primary drivers of Hexcel's largest revenue segment.