UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the Quarter Ended March 31, 2017

or

For the transition period from                      to                    

Commission File Number 1-8472

 

Hexcel Corporation

(Exact name of registrant as specified in its charter)

 

 

Two Stamford Plaza

281 Tresser Boulevard

Stamford, Connecticut 06901-3238

(Address of principal executive offices and zip code)

Registrant’s telephone number, including area code: (203) 969-0666

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes  ☐    No   ☒

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

 

 

 

 

 

 

 

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HEXCEL CORPORATION AND SUBSIDIARIES

INDEX

 

 

 

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. Condensed Consolidated Financial Statements (Unaudited)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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Hexcel Corporation and Subsidiaries

Condensed Consolidated Statements of Operations

 

 

 

Hexcel Corporation and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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Hexcel Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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HEXCEL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1 — Significant Accounting Policies

In these notes, the terms “Hexcel,” “the Company,” “we,” “us,” or “our” mean Hexcel Corporation and subsidiary companies. The accompanying condensed consolidated financial statements are those of Hexcel Corporation. Refer to Note 1 to the consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2016 for a discussion of our significant accounting policies.

Basis of Presentation

The accompanying Condensed Consolidated Financial Statements have been prepared from the unaudited accounting records of Hexcel pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) and in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Certain information and footnote disclosures normally included in financial statements have been omitted pursuant to rules and regulations of the SEC.

In the opinion of management, the Condensed Consolidated Financial Statements include all normal recurring adjustments as well as any non-recurring adjustments necessary to present fairly the statement of financial position, results of operations and cash flows for the interim periods presented. The Condensed Consolidated Balance Sheet as of December 31, 2016 was derived from the audited 2016 consolidated balance sheet. Interim results are not necessarily indicative of results expected for any other interim period or for the full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our 2016 Annual Report on Form 10-K filed with the SEC on February 9, 2017.

Investments in Affiliated Companies

We have a 50% equity ownership investment in a joint venture Aerospace Composites Malaysia Sdn. Bhd. (“ACM”).  This investment is accounted for using the equity method of accounting. In 2016, the Company invested a total of $30.0 million in  three new affiliates. In 2017, the Company invested an additional $10 million in one of these affiliates. The investments are each below a 20% ownership level and the Company accounts for these investments using the cost method.

Recent Accounting Pronouncements

 

In May 2014, the FASB issued Accounting Standard Update No. 2014-09 (ASU 2014-09), “Revenue from Contracts with Customers”. The update clarifies the principles for recognizing revenue and develops a common revenue standard for all industries. The new guidance is effective for the first quarter of 2018. Early application was permitted in 2017 for calendar year entities. Our implementation efforts include the identification of revenue within the scope of the guidance, the evaluation of revenue contracts under the guidance and assessing the qualitative and quantitative impacts of the new standard on our financial statements.  We expect to complete our evaluation by the end of fiscal 2017, which will allow us to select an adoption method and determine the impact that the new standard on our consolidated results of operations and financial condition. The Company plans to adopt the new guidance on January 1, 2018.

In July 2015, the FASB issued Accounting Standards Update No.2015-11 (“ASU 2015-11”), Simplifying the Measurement of Inventory. The update requires that inventory within the scope of the guidance be measured at the lower of cost and net realizable value. The Company adopted this ASU in the first quarter of 2017 with no material impact on our consolidated balance sheets, results of operations and financial condition.

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-02 (ASU 2016-02), Leases. This ASU requires lessees to recognize a right of use asset and lease liability on the balance sheet for all leases, with the exception of short-term leases. The Company will adopt this ASU on January 1, 2019.  We are currently evaluating the impact of adopting this guidance on our consolidated balance sheets, results of operations and financial condition.

In March 2016, the FASB issued Accounting Standards Update No. 2016-06 (ASU 2016-06), Contingent put and call options in debt instruments. The new guidance clarifies that an exercise contingency does not need to be evaluated to determine whether it relates to interest rates and credit risk in an embedded derivative analysis. The new guidance will be effective for fiscal years beginning after December 15, 2016, including interim periods within those years. We adopted ASU 2016-06 effective for the quarter ended March 31, 2017 with no material impact on our consolidated balance sheets, results of operations and financial condition.

       In August of 2016, the FASB issued Accounting Standards Update No. 2016-15 (ASU 2016-15) "Classification of Certain Cash Receipts and Cash Payments” which clarifies the classification of certain types of cash flows. The standard is effective for financial

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statements issued for fiscal years beginning after December 15, 2017. Early adoption beginning in 2016 was permitted. Retrospective application is required. The Company is not early adopting and expects this ASU to have a minimal impact on the Company’s Statements of Cash Flows.

In January 2017, the FASB issued ASU 2017-04, Simplifying the test for Goodwill Impairment, which removes the requirement to compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. As a result, under the ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.. The ASU is effective for annual and interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company early adopted ASU 2017-04 effective for the quarter ended March 31, 2017, for use in its fourth quarter annual goodwill impairment testing.

 

 

 

Note 2 — Net Income per Common Share

 

 

 

Total shares underlying stock options of 0.2 million and 0.6 million were excluded from the computation of diluted net income per share for the quarters ended March 31, 2017 and 2016,  respectively, as they were anti-dilutive.  

 

Note 3 — Inventories

 

 

 

 

Note 4 — Retirement and Other Postretirement Benefit Plans

We maintain qualified and nonqualified defined benefit retirement plans covering certain current and former U.S. and European employees, retirement savings plans covering eligible U.S. and U.K. employees and certain postretirement health care and life insurance benefit plans covering eligible U.S. retirees. We also participate in a union sponsored multi-employer pension plan covering certain U.S. employees with union affiliations.

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Defined Benefit Retirement Plans

Net Periodic Benefit Costs

Net periodic benefit costs of our defined benefit retirement plans for the quarters ended March 31, 2017 and 2016 were as follows:

 

 

 

 

 

 

Contributions

We generally fund our U.S. non-qualified defined benefit retirement plans when benefit payments are incurred. Under the provisions of these non-qualified plans, we have contributed approximately $0.1 million in the first quarter of 2017 to cover unfunded benefits and expect to contribute a total of $1.1 million in 2017. We contributed $0.2 million to our U.S. non-qualified defined benefit retirement plans during 2016.

We contributed $1.3 million and $2.4 million to our European defined benefit retirement plans in the first quarters of 2017 and 2016, respectively. We plan to contribute approximately $5.1 million during 2017 to our European plans. We contributed $6.3 million to our European plans during 2016.

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Postretirement Health Care and Life Insurance Benefit Plans

Net periodic benefit costs of our postretirement health care and life insurance benefit plans for the quarters ended March 31, 2017 and 2016 were not material.

 

In connection with our postretirement plans, we contributed about $0.1 million during each of the quarters ended March 31, 2017 and 2016. We periodically fund our postretirement plans to pay covered expenses as they are incurred. We expect to contribute approximately $0.5 million in 2017 to cover unfunded benefits. We contributed $0.1 million to our postretirement plans during 2016.

 

Note 5 –– Debt

 

 

In February 2017, the Company issued $400 million aggregate principal amount of 3.95% Senior Unsecured Notes due in 2027.  The interest rate on these senior notes may be increased by 0.25% each time a credit rating applicable to the notes is downgraded. The maximum rate is 5.95%. The net proceeds of approximately $394.6 million were initially used to repay, in part, $350 million of our Senior Unsecured Revolving Credit Facility (the “Facility”) and the remainder was used for general purposes including share repurchase.  The conditions and covenants related to the senior notes are less restrictive than those of our Facility. The effective interest rate for the outstanding period in the first quarter was 3.80% inclusive of the approximately 0.25% benefit of the treasury locks. The fair value of the senior notes due in 2027 based on quoted prices utilizing level 2 inputs was $403.2 million at March 31, 2017.

 

In August 2015, the Company issued $300 million aggregate principal amount of 4.7% Senior Unsecured Notes due in 2025.  The interest rate on these senior notes may be increased by 0.25% each time a credit rating applicable to the notes is downgraded. The maximum rate is 6.7%. The net proceeds of approximately $296.4 million were initially used to repay, in part, our Senior Unsecured Revolving Credit Facility (the “Facility”). The conditions and covenants related to the senior notes are less restrictive than those of our Facility. The effective interest rate for the outstanding period in the first quarter was 4.85%. The fair value of the notes due in 2025 based on quoted prices utilizing level 2 inputs was $318.9 million at March 31, 2017.

As of March 31, 2017, total borrowings under our $700 million Facility were $85 million, which approximates fair value using level 2 inputs. The Company utilized its Facility at various borrowing levels with $430 million and $440 million representing the highest amounts borrowed within the three months ended March 31, 2017 and 2016, respectively. The Facility permits us to issue letters of credit up to an aggregate amount of $40 million. Outstanding letters of credit reduce the amount available for borrowing under our revolving loan. As of March 31, 2017, we had issued letters of credit under the Facility totaling $0.2 million, resulting in undrawn availability under the Facility as of March 31, 2017 of $614.8 million.

The Facility contains financial and other covenants, including, but not limited to, restrictions on the incurrence of debt and the granting of liens, as well as the maintenance of an interest coverage ratio and a leverage ratio.  In accordance with the terms of the  

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Facility, we are required to maintain a minimum interest coverage ratio of 3.50 (based on the ratio of EBITDA, as defined in the credit agreement, to interest expense) and may not exceed a maximum leverage ratio of 3.50 (based on the ratio of total debt to EBITDA) throughout the term of the Facility.  In addition, the Facility contains other terms and conditions such as customary representations and warranties, additional covenants and customary events of default. The average interest rate on the Facility was 2.75% for the first quarter of 2017. The average interest rate was 2.16% for 2016.

In June 2016, we entered into a €60 million  term loan.  The loan has two tranches of which the first tranche for €25 million had a six month availability period at a rate of Euribor +1.2% and a final maturity date of June 30, 2023. The second tranche for €35 million has a one year availability period at a rate of Euribor +1.25% and a final maturity date of June 30, 2024. There is a zero percent floor on the Euribor. The loans are payable in annual installments, beginning on June 30, 2017 and June 30, 2019, respectively. We had drawn the entire available amount of €60 million, or $64.1 million outstanding under this loan at March 31, 2017, which approximates fair value. The facility is guaranteed by Hexcel Corporation.

 

 

 

 

Note 6 — Derivative Financial Instruments

Interest Rate Swap and Interest Lock Agreements

     During the first quarter of 2017, $50 million of interest rate swaps matured.  As of March 31, 2017, the Company had remaining agreements to swap $50 million of floating rate obligations for fixed rate obligations at an average of 1.087% against LIBOR in U.S. dollars which matures in September 2019. The swaps were accounted for as cash flow hedges of our floating rate bank loans. To ensure the swaps were highly effective, all of the principal terms of the swaps matched the terms of the bank loans. The fair value of the interest rate swaps was an asset of $0.7 million at March 31, 2017 and an asset of $0.6 million at December 31, 2016.

In December 2016 we swapped € 25.0 million of floating  rate obligations for fixed rate obligations at a rate of 0.365% against EURIBOR in Euros. The swap amortizes over seven equal annual installments beginning June 30, 2017 until the final maturity on June 30, 2023.  The derivative is accounted for as a cash flow hedge of the floating rate French term loan.  To ensure the swap is highly effective, all the principal terms of the swap matched the terms of the bank loan. The fair value of the interest rate swap was a liability of less than $0.1 million at March 31, 2017 and a liability of $0.1 million at December 31, 2016.

          The Company also uses treasury locks to protect against unfavorable movements in the benchmark treasury rate related to forecasted debt issuances. On September 22, 2016 and February 7, 2017, the Company entered into interest rate treasury lock agreements with notional values of $150 million and $100 million for a forecasted 2017 debt issuance.  We accounted for these interest rate treasury locks as cash flow hedges so any change in fair value was recorded into other comprehensive income and then amortized into interest expense over the life of the bonds upon issuance. On February 15, 2017 we issued senior notes due 2027, and received $10.0 million in cash in settlement of the derivatives. The amount recorded in other comprehensive income will be released to interest expense over the life of the senior notes. The effect of these treasury locks is to reduce the interest rate on the senior notes by approximately 0.25%.

Foreign Currency Forward Exchange Contracts

A number of our European subsidiaries are exposed to the impact of exchange rate volatility between the U.S. dollar and the subsidiaries’ functional currencies, being either the Euro or the British Pound sterling. We entered into contracts to exchange U.S. dollars for Euros and British Pound sterling through September 2019, which we account for as cash flow hedges. The aggregate notional amount of these contracts was $389.7 million and $423.8 million at March 31, 2017 and December 31, 2016, respectively. The purpose of these contracts is to hedge a portion of the forecasted transactions of European subsidiaries under long-term sales contracts with certain customers. These contracts are expected to provide us with a more balanced matching of future cash receipts and expenditures by currency, thereby reducing our exposure to fluctuations in currency exchange rates. The effective portion of the hedges, gains of $3.4 million and $5.8 million, respectively, were recorded in other comprehensive income (“OCI”) for the three months ended March 31, 2017 and 2016. We classified the carrying amount of these contracts of $0.3 million in other assets and $24.3 million in other liabilities on the Condensed Consolidated Balance Sheets at March 31, 2017 and $33.9 million in other liabilities at December 31, 2016. During the three months ended March 31, 2017 and 2016, we recognized net losses of $6.6 million and $5.2 million in gross margin, respectively. For the quarters ended March 31, 2017 and 2016, hedge ineffectiveness was immaterial.

In addition, we enter into foreign exchange forward contracts which are not designated as hedges. These are used to provide an offset to transactional gains or losses arising from the remeasurement of non-functional monetary assets and liabilities such as accounts receivable.  The change in the fair value of the derivatives is recorded in the statement of operations. There are no credit contingency features in these derivatives. During the quarters ended March 31, 2017 and 2016, we recognized net foreign exchange

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gains of $1.5 million and $4.2 million, respectively, in the Condensed Consolidated Statements of Operations. The net foreign exchange impact recognized from these hedges offset the translation exposure of these transactions. The carrying amount of the contracts for asset and liability derivatives not designated as hedging instruments was $1.0 million classified in other assets and $0.5 million in other liabilities and $1.0 million classified in other assets and $0.3 million in other liabilities on the March 31, 2017 and December 31, 2016 Condensed Consolidated Balance Sheets, respectively.

The change in fair value of our foreign currency forward exchange contracts under hedge designations recorded net of tax within accumulated other comprehensive income for the quarters ended March 31, 2017 and 2016 was as follows:

 

 

We expect to reclassify $12.8 million of unrealized losses into earnings over the next twelve months as the hedged sales are recorded.

 

 

Note 7 — Income Taxes

 

The income tax provision for the quarter ended March 31, 2017 was $8.6 million, including a nonrecurring discrete benefit of $9.1 million from the release of a valuation allowance in a foreign jurisdiction. The effective tax rate, excluding this benefit, for the first quarter was 24.4% as compared to 29.0% in 2016, as both periods benefitted from deductions associated with share based compensation payments, as activity is typically higher in the first quarter.  Excluding these discrete benefits, the Company’s first quarter effective tax rate was 30%, in line with our full year expectations.   
   
      

 

Note 8 — Fair Value Measurements

The authoritative guidance for fair value measurements establishes a hierarchy for observable and unobservable inputs used to measure fair value, into three broad levels, which are described below:

In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as consider counterparty credit risk in our assessment of fair value.

We do not have any significant assets or liabilities that utilize Level 3 inputs. In addition, we have no assets or liabilities that utilize Level 1 inputs. For derivative assets and liabilities that utilize Level 2 inputs, we prepare estimates of future cash flows of our derivatives, which are discounted to a net present value. The estimated cash flows and the discount factors used in the valuation model are based on observable inputs, and incorporate non-performance risk (the credit standing of the counterparty when the derivative is in a net asset position, and the credit standing of Hexcel when the derivative is in a net liability position). The fair value of these assets and liabilities was approximately $1.9 million and $24.8 million, respectively, at March 31, 2017. In addition, the fair value of these derivative contracts, which are subject to a master netting arrangement under certain circumstances, is presented on a gross basis in the consolidated balance sheet.

Below is a summary of valuation techniques for all Level 2 financial assets and liabilities:

 

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Counterparties to the above contracts are highly rated financial institutions, none of which experienced any significant downgrades in the quarter ended March 31, 2017 that would reduce the receivable amount owed, if any, to the Company.

 

Note 9 — Segment Information

The financial results for our operating segments are prepared using a management approach, which is consistent with the basis and manner in which we internally segregate financial information for the purpose of assisting in making internal operating decisions. We evaluate the performance of our operating segments based on operating income, and generally account for intersegment sales based on arm’s length prices. Corporate and certain other expenses are not allocated to the operating segments, except to the extent that the expense can be directly attributable to the business segment.

Financial information for our operating segments for the quarters ended March 31, 2017 and 2016 is as follows:

 

Goodwill and Intangible Assets

The carrying amount of gross goodwill and intangible assets by segment is as follows:

 

 

No impairments have been recorded against these amounts.

 

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Note 10 — Accumulated Other Comprehensive Loss

 

Comprehensive income represents net income and other gains and losses affecting stockholders’ equity that are not reflected in the consolidated statements of operations. The components of accumulated other comprehensive loss as of March 31, 2017 and December 31, 2016 were as follows:

 

 

 

The amounts reclassified to earnings from the unrecognized net defined benefit plan costs component of accumulated other comprehensive loss for the quarter ended March 31, 2017 were net losses of $0.2 million less taxes of $0.1 million primarily due to the amortization of net actuarial losses. The amounts reclassified to earnings from the change in fair value of the derivatives component of accumulated other comprehensive loss for the quarter ended March 31, 2017 were net gains of $6.6 million less taxes of $1.6 million related to foreign currency forward exchange contracts and net losses of $0.2 million less taxes of $0.1 million related to interest swaps. The currency translation adjustments are not currently adjusted for income taxes as they relate to indefinite investments in non-U.S. subsidiaries.

 

 

 

Note 11 — Commitments and Contingencies

We are involved in litigation, investigations and claims arising out of the normal conduct of our business, including those relating to commercial transactions, environmental, employment, and health and safety matters. We estimate and accrue our liabilities when a loss becomes probable and estimable. These judgments take into consideration a variety of factors, including the stage of the proceeding; potential settlement value; assessments by internal and external counsel; and assessments by environmental engineers and consultants of potential environmental liabilities and remediation costs. Such estimates are not discounted to reflect the time value of money due to the uncertainty in estimating the timing of the expenditures, which may extend over several years.

While it is impossible to ascertain the ultimate legal and financial liability with respect to certain contingent liabilities and claims, we believe, based upon our examination of currently available information, our experience to date, and advice from legal counsel, that the individual and aggregate liabilities resulting from the ultimate resolution of these contingent matters, after taking into consideration our existing insurance coverage and amounts already provided for, will not have a material adverse impact on our consolidated results of operations, financial position or cash flows.

Environmental Matters

We are subject to various international, U.S., state and local environmental, and health and safety laws and regulations. We are also subject to liabilities arising under the Federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA” or “Superfund”), the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, and similar state and international laws and regulations that impose responsibility for the control, remediation and abatement of air, water and soil pollutants and the manufacturing, storage, handling and disposal of hazardous substances and waste.

We have been named as a potentially responsible party (“PRP”) with respect to several hazardous waste disposal sites that we do not own or possess, which are included on, or proposed to be included on, the Superfund National Priority List of the U.S. Environmental Protection Agency (“EPA”) or on equivalent lists of various state governments. Because CERCLA allows for joint and several liability in certain circumstances, we could be responsible for all remediation costs at such sites, even if we are one of many PRPs. We believe, based on the amount and nature of our waste, our existing insurance coverage, the amounts already provided for and the number of other financially viable PRPs, that our liability in connection with such matters will not be material.

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Lower Passaic River Study Area

Hexcel and a group of approximately 52 other PRPs comprise the Lower Passaic Cooperating Parties Group (the “CPG”). Hexcel and the CPG are subject to a May 2007 Administrative Order on Consent (“AOC”) to perform a Remedial Investigation/Feasibility Study (“RI/FS”) of environmental conditions in the Lower Passaic River watershed. We were included in the CPG based on our operations at our former manufacturing site in Lodi, New Jersey.

In March 2016, the EPA issued a Record of Decision (“ROD”) setting forth the EPA’s selected remedy for the lower eight miles of the river. The ROD calls for capping and dredging of the lower eight miles of the Passaic River, with the placement of an engineered cap over the entire eight miles, at an expected cost ranging from $0.97 billion to $2.07 billion, according to the EPA. Because the EPA has not yet selected a remedy for the upper nine miles of the Lower Passaic River, this estimate range does not include any costs related to a future remedy for the upper portion of the river. Now that it has issued the final ROD, the EPA will seek to hold some combination of the PRPs liable to perform the work selected through the ROD. At this point, we have not yet determined our allocable share of performing the selected remedy. However, based on a review of the Company’s position, and as no point within the range is a more probable outcome than any other point, the Company has determined that its accrual is sufficient at this time. The accrual balance was $2.0 million and $2.1 million as of March 31, 2017 and December 31, 2016, respectively. Despite the issuance of the final ROD, there continue to be many uncertainties associated with the selected remedy, the Company’s allocable share of the remediation and the amount of insurance coverage. Given those uncertainties, the amounts accrued may not be indicative of the amounts for which the Company is ultimately responsible and will be refined as events in the remediation process develop.

 

Omega Chemical Corporation Superfund Site, Whittier, California

We are a PRP at a former chemical waste site in Whittier, California. The PRPs at Omega have established a PRP Group, (the “Omega PRP Group”), and are currently investigating and remediating soil and groundwater at the site pursuant to a Consent Decree with the EPA. The Omega PRP Group has attributed approximately 1.07% of the waste tonnage sent to the site to Hexcel.  In addition to the Omega site specifically, the EPA is investigating the scope of regional groundwater contamination in the vicinity of the Omega site and issued a Record of Decision; the Omega PRP Group members have been served notice by the EPA as PRPs who will be required to be involved in the remediation of the regional groundwater contamination in that vicinity as well.  As a member of the Omega PRP Group, Hexcel will incur costs associated with the investigation and remediation of the Omega site and the regional groundwater remedy, although our ultimate liability, if any, in connection with this matter cannot be determined at this time. The total accrued liability relating to potential liability for both the Omega site and regional groundwater remedies was $0.6 million at both March 31, 2017 and at December 31, 2016, respectively.

Summary of Environmental Reserves

Our estimate of liability as a PRP and our remaining costs associated with our responsibility to remediate the Lower Passaic River and other sites are accrued in the consolidated balance sheets. As of March 31, 2017, our aggregate environmental related accruals were $3.1 million, of which $1.4 million was included in accrued liabilities with the remainder included in non-current liabilities.  As of December 31, 2016, our aggregate environmental related accruals were $3.2 million, of which $1.4 million was included in accrued liabilities with the remainder included in non-current liabilities. As related to certain environmental matters the accrual was estimated at the low end of a range of possible outcomes since no amount within the range is a better estimate than any other amount. If we had accrued at the high end of the range of possible outcomes for those sites where we are able to estimate our liability, our accrual would have been $16 million higher. These accruals can change significantly from period to period due to such factors as additional information on the nature or extent of contamination, the methods of remediation required, changes in the apportionment of costs among responsible parties, amount of insurance coverage, and other actions by governmental agencies or private parties, or the impact, if any, of being named in a new matter.

Environmental remediation spending charged to our reserve balance for each of the quarters ended March 31, 2017 and 2016 was $0.1 million. In addition, our operating costs relating to environmental compliance charged to expense were $2.4 million and $2.3 million for the quarters ended March 31, 2017 and 2016, respectively.

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Product Warranty

We provide for an estimated amount of product warranty expense which is provided by product and based on historical warranty experience. In addition, we periodically review our warranty accrual and record any adjustments as deemed appropriate. Warranty expense for the quarter ended March 31, 2017, and accrued warranty cost, included in “accrued liabilities” in the condensed consolidated balance sheets at March 31, 2017 and December 31, 2016, were as follows:

 

 

 

Note 12 — Stock Repurchase Plan

In October 2015, our Board authorized the repurchase of $250 million of the Company’s stock (“2015 Repurchase Plan”).   In the first quarter of 2017, the Company spent $63.7 million to repurchase our common stock and at March 31, 2017, the Company has $29.1 million remaining under the 2015 Repurchase Plan. 

On February 9, 2017, our Board authorized the repurchase of $300 million of the Company’s stock (“2017 Repurchase Plan”).

                

 

 

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business Overview

We develop, manufacture, and market lightweight, high-performance structural materials, including carbon fibers, specialty reinforcements, prepregs and other fiber-reinforced matrix materials, honeycomb, adhesives, engineered core and composite structures, for use in Commercial Aerospace, Space & Defense and Industrial markets. Our products are used in a wide variety of end applications, such as commercial and military aircraft, space launch vehicles and satellites, wind turbine blades, automotive, recreational products and other industrial applications.

 

We serve international markets through manufacturing facilities, sales offices and representatives located in the Americas, Asia Pacific, Europe, Russia and Africa. We are also a partner in a joint venture in Malaysia, which manufactures composite structures for Commercial Aerospace applications.

 

Hexcel has two segments, Composite Materials and Engineered Products. The Composite Materials segment is comprised of our carbon fiber, specialty reinforcements, resins, prepregs and other fiber-reinforced matrix materials, and honeycomb core product lines.  The Engineered Products segment is comprised of lightweight high strength composite structures, molded components and specialty machined honeycomb products with added functionality.

 

Net sales for the quarter were $478.8 million, 3.8% lower (2.6% lower in constant currency) than the $497.7 million reported for the first quarter of 2016.  Commercial Aerospace and Space & Defense sales were comparable to last year, while Industrial sales were 19.4% below last year (16.1% in constant currency).

Commercial Aerospace sales of $347.2 million were 0.9% lower (0.3% in constant currency) for the quarter as compared to the first quarter of 2016. While the sales growth of the A350 and the new narrowbodies were in line with expectations, the growth was offset by the declines in certain legacy widebody sales (i.e. A380, B777 and B747).

Sales to other commercial aerospace, which include regional and business aircraft customers, were down modestly from the first quarter of 2016 and just above the fourth quarter of 2016.

Space & Defense sales of $76.7 million were 3.3% lower (1.7% in constant currency) than the first quarter of 2016. Rotorcraft sales comprise just over half of Space & Defense sales with civil rotorcraft sales remaining at historic low levels and now comprise about 10% of total rotorcraft sales.

Total Industrial sales of $54.9 million for the first quarter of 2017 were 19.4% lower (16.1% lower in constant currency) than the first quarter of 2016 and were just higher than the fourth quarter of 2016. We expect sales to be more level loaded by quarter in 2017, as sales for the second half of 2016 were nearly 20% lower than the first half of 2016. As expected, wind energy sales are in for a challenging year and were down more than 25%.  However, we expect wind energy sales in 2018 to exceed 2016 levels, as various legacy blades with lower composite content transition to longer, higher efficiency blades with higher composite content.

Gross margin for the first quarter of 2017 was a solid 28.0% as compared to 28.7% for the first quarter of 2016. We are on track with training and start-up costs at the previously announced two new greenfield manufacturing sites in France and Morocco.

Selling, general and administrative expenses were $4.5 million lower than the first quarter of 2016. This is about a 7% reduction in constant currency and reflects strong cost control. Research and technology expenses were $0.9 million higher (11% higher in constant currency) than the comparable 2016 period as we continue to invest in innovative composite products and solutions to support our customers.

Free cash flow (defined as cash provided by operating activities less capital expenditures) for the first quarter of 2017 was a use of $31 million versus a use of $75 million in 2016 as seasonal effects typically cause significant working capital cash usage in the first quarter. Working capital usage in the first quarter of 2017 was $40 million versus a usage of $91 million in the first quarter of 2016. Cash used for capital expenditures was about $85 million for both quarters. Accrual basis additions to capital expenditures were $93 million in the first quarter of 2017 as compared to $73 million during the first quarter of 2016. We expect accrual basis capital expenditures to be in the $270 million to $290 million range in 2017, as we continue to expand capacity to meet the planned needs of our customers.  The driver of our capital expenditures is capacity additions for the planned ramp-up of new aerospace programs.

 

 

 

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Financial Overview

Results of Operations

 

 

The Company’s performance measurements include sales measured in constant dollars, net income adjusted for special items and free cash flow, all of which are non-GAAP measures.  Management believes these non-GAAP measurements are meaningful to investors because they provide a view of Hexcel with respect to ongoing operating results.  Special items represent significant charges or credits that are important to understanding Hexcel’s overall operating results in the periods presented. Such non-GAAP measurements are not recognized in accordance with generally accepted accounting principles and should not be viewed as an alternative to GAAP measures of performance.  The following is a reconciliation from GAAP to non-GAAP amounts.

 

 

 

 

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Net Sales

 

The following table summarizes net sales to third-party customers by segment and end market for the quarters March 31, 2017 and 2016:

 

 

Sales by Segment

 

Composite Materials: Net sales of $387.5 million in the first quarter of 2017 decreased $8.3 million from the $395.8 million in the prior year driven by a 19.5% decrease in Industrial sales combined with Commercial Aerospace and Space & Defense sales that were comparable to last year. As expected, wind energy sales are in for a challenging year and were down more than 25%.  However, the Company expects wind energy sales in 2018 to exceed 2016 levels, once the transition from certain blade models with lower composite content to longer blades with higher content in 2018 is completed.

 

Engineered Products: Net sales of $91.3 million in the first quarter of 2017 decreased $10.6 million from the $101.9 million for 2016 as driven by a decline in Commercial Aerospace sales, primarily due to the decline in the legacy widebody rates as well the decline in civil rotorcraft sales, which remain at historic low levels.

 

Sales by Market

 

Commercial Aerospace: Commercial Aerospace sales of $347.2 million were 0.9% lower (0.3% in constant currency) for the quarter as compared to the first quarter of 2016. While the sales growth of the A350 and the new narrowbodies were in line with expectations, the growth was offset by the declines in certain legacy widebody sales (i.e. A380, B777 and B747).

 

Sales to other commercial aerospace, which include regional and business aircraft customers, were down modestly from the first quarter of 2016 and just above the fourth quarter of 2016.

 

Space & Defense: Net sales of $76.7 million were 3.3% lower (1.7% in constant currency) for the quarter as compared to the first quarter of 2016.  Rotorcraft sales comprise just over half of Space & Defense sales with civil rotorcraft sales remaining at historic low levels and now comprise about 10% of total rotorcraft sales.

 

Industrial: Net sales of $54.9 million for the first quarter of 2017 were 19.4% lower (16.1% lower in constant currency) than the first quarter of 2016 and were just higher than the fourth quarter of 2016. Sales are expected to be more level loaded by quarter in 2017, as sales for the first half of 2016 were more than 25% lower than the second half of 2016. As expected, wind energy sales are in for a challenging year and were down more than 25%.  However, wind energy sales in 2018 are expected to exceed 2016 levels, as various legacy blades with lower composite content transition to longer, higher efficiency blades with higher composite content.

 

 

 

 

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Gross Margin

 

 

Gross margin percentage was 28.0% as compared to 28.7% for the first quarter of 2016. The Company is on track with training and start-up costs at the previously announced two new greenfield manufacturing sites in France and Morocco.

 

Operating Expenses

 

 

Selling, general and administrative expenses were $4.5 million lower than the first quarter of 2016. This is about a 7% reduction in constant currency and reflects strong cost control. Research and technology expenses were $0.9 million higher (11% higher in constant currency) than the comparable 2016 period as we continue to invest in innovative composite products and solutions to support our customers.

 

Operating Income

 

 

Operating income in the 2017 first quarter was $78.6 million or 16.4% of sales as compared to $83.9 million or 16.9% of sales in 2016. Depreciation and amortization was $2.7 million higher this quarter, on a constant currency basis, than a year ago. The 2017 operating income percentage as compared to 2016 was nearly 40 basis points higher from exchange rates.

Interest Expense, Net

 

 

Interest expense for the first quarter ended March 31, 2017 increased over the comparable period of 2016 due to higher average interest rate on debt outstanding as a result of the Company issuing, in February 2017, $400 million aggregate principal amount of 3.95% Senior Unsecured Notes due in 2027.  In addition, debt increased as we continue to invest in capacity, while also returning funds to stockholders through stock buybacks and dividends.

 

Provision for Income Taxes      

 

 

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  The tax provision was $8.6 million for the quarter, including a discrete benefit of $9.1 million from the release of a valuation allowance in a foreign jurisdiction. Excluding this discrete benefit, the effective tax rate was 24.4% as compared to 29.0% in 2016. Both periods benefitted from deductions associated with share-based compensation payments, as activity is typically highest in the first quarter. Excluding these discrete benefits, the Company’s first quarter effective tax rate was 30%, in line with our full year expectations.

  

Financial Condition

 

Liquidity: As of March 31, 2017, our total debt, net of cash, was $759.1 million, as compared to $653.5 million at December 31, 2016. The increase in debt in the first quarter of 2017 primarily reflects $64 million in stock repurchases and the free cash flow usage of $31 million. In February 2017, the Company issued $400 million aggregate principal amount of 3.95% Senior Unsecured Notes due in 2027.  The interest rate on these senior notes may be increased by 0.25% each time a credit rating applicable to the notes is downgraded. The maximum rate is 5.95%. The net proceeds of approximately $394.6 million were initially used to repay, in part, $350 million of our Senior Unsecured Revolving Credit Facility (the “Facility”) and the remainder was used for general purposes including share repurchase. At March 31, 2017, total borrowings under our $700 million Senior Unsecured Credit Facility (the “Facility”) were $85 million. The Facility permits us to issue letters of credit up to an aggregate amount of $40.0 million.  Outstanding letters of credit reduce the amount available for borrowing under our revolving loan.  As of March 31, 2017, we had issued letters of credit under the Facility totaling $0.2 million, resulting in undrawn availability under the Facility as of March 31, 2017 of $614.8 million.  

The Facility contains financial and other covenants, including, but not limited to, restrictions on the incurrence of debt and the granting of liens, as well as the maintenance of an interest coverage ratio and a leverage ratio. In accordance with the terms of the Facility, we are required to maintain a minimum interest coverage ratio of 3.50 (based on the ratio of EBITDA, as defined in the credit agreement, to interest expense) and may not exceed a maximum leverage ratio of 3.50 (based on the ratio of total debt to EBITDA) throughout the term of the Facility.  In addition, the Facility contains other terms and conditions such as customary representations and warranties, additional covenants and customary events of default. The conditions and covenants related to the senior notes are less restrictive than those of our Facility. As of March 31, 2017, we were in compliance with all debt covenants and expect to remain in compliance.

We expect to meet our short-term liquidity requirements (including capital expenditures) through net cash from operating activities, cash on hand and the Facility. As of March 31, 2017, long-term liquidity requirements consist primarily of obligations under our long-term debt obligations. We do not have any significant required debt repayments until September 2021 when the Facility expires.

Operating Activities: Net cash provided by operating activities was $54.2 million in the first three months of 2017, as compared to $10.3 million in the first three months of 2016. Working capital usage in the first quarter of 2017 was $40 million versus a usage of $91 million in the first quarter of 2016.

Investing Activities: Net cash used for investing activities of $95.5 million and $94.0 million in the first quarter of 2017 and 2016, respectively, was for capital expenditures and investments.

In 2017, we made an additional $10 million investment in Oxford Performance Materials (“OPM”) based on the achievement of certain milestones. OPM produces thermoplastic, carbon fiber reinforced 3D printed parts for aerospace and medical applications. The investment in 2016 represented the acquisition of the remaining 50% of Formax.

 

Financing Activities: Financing activities generated $87.8 million and $54.9 million of net cash in the first quarter of 2017 and 2016. The first quarter of 2017 reflects $400 million from the issuance of the 3.95% notes, partly offset by the repayment of $280 million of the Facility, and $73.8 million returned to stockholders from stock repurchases and dividends. The first quarter of 2016 primarily reflects increased borrowings of $104.0 million from the Facility less $43.8 million returned to stockholders from stock repurchases and dividends.

In 2017, the Company repurchased $63.7 million of shares of common stock under the 2015 Repurchase Plan. In October 2015, our Board authorized the repurchase of $250 million of the Company’s stock (“2015 Repurchase Plan”) and now has $29.1 million remaining under the 2015 Repurchase Plan. In February 2017, our Board authorized the repurchase of an additional $300 million of the Company’s stock (“2017 Repurchase Plan”).

 

Financial Obligations and Commitments: As of March 31, 2017, current portion of debt includes $0.4 million in current maturities of a capital lease that was an obligation assumed from the Formax acquisition and $4.8 million related to the Euro term loan.

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The next significant scheduled debt maturity will not occur until 2021, the year the senior unsecured credit facility matures. Certain sales and administrative offices, data processing equipment and manufacturing facilities are leased under operating leases.

Critical Accounting Estimates

Our Condensed Consolidated Financial Statements are prepared in accordance with U.S. GAAP. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect reported amounts of assets, liabilities, revenues, expenses and related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors management believes to be relevant at the time our condensed consolidated financial statements are prepared. On a regular basis, management reviews accounting policies, assumptions, estimates and judgments to ensure our financial statements are presented fairly and in accordance with U.S. GAAP. However, because future events and their effects cannot be determined with certainty, actual results may differ from our assumptions and estimates, and such differences could be material.

We describe our significant accounting policies and critical accounting estimates in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

 

Commitments and Contingencies

We are involved in litigation, investigations and claims arising out of the normal conduct of our business, including those relating to commercial transactions, environmental, employment and health and safety matters. We estimate and accrue our liabilities resulting from such matters based upon a variety of factors, including the stage of the proceeding; potential settlement value; assessments by internal and external counsel; and assessments by environmental engineers and consultants of potential environmental liabilities and remediation costs. We believe we have adequately accrued for these potential liabilities; however, facts and circumstances may change, such as new developments, or a change in approach, including a change in settlement strategy or in an environmental remediation plan, that could cause the actual liability to exceed the estimates, or may require adjustments to the recorded liability balances in the future.

Our estimate of liability as a PRP and our remaining costs associated with our responsibility to remediate the Lower Passaic River in New Jersey and other sites are accrued in the consolidated balance sheets. As of March 31, 2017, our aggregate environmental related accruals were $3.1 million, of which $1.4 million was included in accrued liabilities, with the remainder included in non-current liabilities. As related to certain environmental matters, the accrual was estimated at the low end of a range of possible outcomes since no amount within the range is a better estimate than any other amount. If we had accrued, for those sites where we are able to estimate our liability, at the high end of the range of possible outcomes, our accrual would have been $16 million higher. These accruals can change significantly from period to period due to such factors as additional information on the nature or extent of contamination, the methods of remediation required, changes in the apportionment of costs among responsible parties, the amount of insurance coverage and other actions by governmental agencies or private parties, or the impact, if any, of being named in a new matter. 

 

Forward-Looking Statements

Certain statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information that are based on forecasts of future results and estimates of amounts not yet determinable. These statements also relate to future prospects, developments and business strategies. These forward-looking statements are identified by their use of terms and phrases such as “anticipate”, “believe”, “could”, “estimate”, “expect”, “intend”, “may”, “plan”, “predict”, “project”, “should”, “would”, “will” and similar terms and phrases, including references to assumptions. Such statements are based on current expectations, are inherently uncertain, and are subject to changing assumptions.

Such forward-looking statements include, but are not limited to: (a) the estimates and expectations based on aircraft production rates made publicly available by Airbus, Boeing and others; (b) the revenues we may generate from an aircraft model or program; (c) the impact of the possible push-out in deliveries of the Airbus and Boeing backlog and the impact of delays in the startup or ramp-up of new aircraft programs or the final Hexcel composite material content once the design and material selection has been completed; (d) expectations of composite content on new commercial aircraft programs and our share of those requirements; (e) expectations of growth in revenues from space and defense applications, including whether certain programs might be curtailed or discontinued; (f) expectations regarding growth in sales for wind energy, recreation, automotive and other industrial applications; (g) expectations regarding working capital trends and expenditures; (h) expectations as to the level of capital expenditures and when we will complete the construction and qualification of capacity expansions; (i) our ability to maintain and improve margins in light of the ramp-up of

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capacity and new facilities and the current economic environment; (j) the outcome of legal matters; (k) our projections regarding the realizability of net operating loss and tax credit carryforwards; and (l) the impact of various market risks, including fluctuations in interest rates, currency exchange rates, environmental regulations and tax codes, fluctuations in commodity prices, and fluctuations in the market price of our common stock, the impact of work stoppages or other labor disruptions and the impact of the above factors on our expectations of 2017 financial results and beyond. In addition, actual results may differ materially from the results anticipated in the forward looking statements due to a variety of factors, including but not limited to changing market conditions, increased competition, product mix, inability to achieve planned manufacturing improvements or to meet customer specifications, cost reductions and capacity additions, and conditions in the financial markets.

Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results to be materially different.  Such factors include, but are not limited to, the following: changes in general economic and business conditions; changes in current pricing and cost levels; changes in political, social and economic conditions and local regulations; foreign currency fluctuations; changes in aerospace delivery rates; reductions in sales to any significant customers, particularly Airbus, Boeing or Vestas; changes in sales mix; changes in government defense procurement budgets; changes in military aerospace programs technology; industry capacity; competition; disruptions of established supply channels, particularly where raw materials are obtained from a single or limited number of sources and cannot be substituted by unqualified alternatives; manufacturing capacity constraints; uncertainty regarding the exit of the U.K. from the European Union; and unforeseen vulnerability of our network and systems to interruptions or failures.

If one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect, actual results may vary materially from those expected, estimated or projected. In addition to other factors that affect our operating results and financial position, neither past financial performance nor our expectations should be considered reliable indicators of future performance. Investors should not use historical trends to anticipate results or trends in future periods. Further, our stock price is subject to volatility. Any of the factors discussed above could have an adverse impact on the price of our securities. In addition, failure of sales or income in any quarter to meet the investment community’s expectations, as well as broader market trends, can have an adverse impact on the price of our securities. We do not undertake an obligation to update our forward-looking statements or risk factors to reflect future events or circumstances.

 

 

 

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

There are no material changes in market risk from the information provided in the Company’s 2016 Annual Report on Form 10-K.

 

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ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have evaluated our disclosure controls and procedures as of March 31, 2017 and have concluded that these disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file or submit is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Our Chief Executive Officer and Chief Financial Officer have concluded that there have not been any changes in our internal control over financial reporting during the first quarter of 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

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PART II. OTHER INFORMATION

 

ITEM 1. Legal Proceedings

The information required by Item 1 is contained within Note 11 on pages 13 through 15 of this Form 10-Q and is incorporated herein by reference.

 

ITEM 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016, which could materially affect our business, financial condition or future results. In addition, future uncertainties may increase the magnitude of these adverse effects or give rise to additional material risks not now contemplated.

 

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

 

ITEM 5. Other Information

Not applicable

 

ITEM 6. Exhibits

 

 

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Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

 

 

 

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EXHIBIT INDEX

 

 

 

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