(a) Earnings before business acquisition and consolidation expenses, other income, interest, taxes, depreciation and amortization. See also “Financial Condition and Liquidity” for a reconciliation of net income to EBITDA and Adjusted EBITDA.
(b) Excludes business acquisition and consolidation expenses and other income.
(c) Excludes business acquisition and consolidation expenses and assumes a U.S. effective tax provision of 36%.

Hexcel closed its 1998 fiscal year with record sales, Adjusted operating income and Adjusted EBITDA. In the three years since the bottom of the aerospace cycle in 1995, the company has more than tripled its sales and has established a solid record of profitability: gross margin increased from 19.2% to 24.9%, Adjusted EBITDA improved from $29.4 million to $177.2 million, or a 503% increase, and Adjusted net income increased more than 17 times from $3.3 million to $59.2 million.

This dramatic turnaround was a result of three major factors. First, the company led the consolidation of the advanced structural materials industry through its acquisitions of the Ciba and Hercules composite materials businesses in 1996, and through the acquisition of the industrial fabrics business from Clark-Schwebel in 1998. The company’s most recent acquisition diversifies Hexcel’s business beyond its base in commercial aerospace and establishes Hexcel as a leading global materials supplier to the electronics industry. Second, commercial aerospace build rates significantly increased, which led to record deliveries for Boeing and Airbus during 1998. In 1998, there were 788 combined aircraft deliveries as compared to 380 in 1995. Finally, the company substantially completed a business consolidation program that eliminated excess capacity and integrated the Ciba and Hercules businesses.

Although the company achieved record performance in 1998, there were significant global changes in some of its markets which were triggered by the Asian economic recession. Deferred or canceled aircraft orders by Pacific Rim nations led to a reduction in Boeing’s projected build rates. While the company will still benefit from the combined estimated sustained production levels that should be well above 700 aircraft annually, developing other existing markets and new applications for advanced structural materials will now be an important driver of future growth for Hexcel. Lower anticipated future commercial aircraft deliveries and Boeing’s well publicized profitability and production issues resulted in Hexcel’s customers now emphasizing the need for material yield improvement and cost and inventory reduction throughout the commercial aerospace supply chain.

The events in Asia also impacted the markets for fiberglass electronic materials. Reduced Asian market demand and weak exchange rates have contributed to certain Asian producers seeking to sell their products in western markets. This has caused intense competition in the fiberglass fabric markets that the company serves. The impact of lower commercial aerospace orders and these competitive factors in the electronic materials market are currently anticipated to result in the company’s net sales being flat in 1999 compared to pro forma 1998 revenues. Responding to these market changes, both to remain competitive and sustain profitability, Hexcel has intensified its efforts to improve efficiencies and reduce total cost through its Lean Enterprise and value chain initiatives, as well as its business consolidation activities.

Looking forward, the company has positioned itself for the future through the issuance of $240.0 million of Senior Subordinated Notes, due 2009, to solidify its long-term capital structure. Business plans are focused on adjusting the company’s cost and manufacturing capacity to earn attractive returns and on generating free cash flow to repay debt. Hexcel’s short-term goal is to generate $100 million of free cash flow, before taking into account the purchase of an equity interest in CS-Interglas, in the fifteen month period from October 1, 1998 to December 31, 1999. In the fourth quarter of 1998, the company generated approximately $15 million in free cash flow before paying $19.0 million for its initial 43.6% equity interest in CS-Interglas, leaving approximately $85 million of the goal to be generated in 1999.

R e c e n t   D e v e l o p m e n t s

During the first quarter of 1999, demand in most of the markets that Hexcel serves, including commercial aerospace, has been in line with the company’s expectations. In addition, the company has continued to make progress in its business consolidation and integration action plans. However, competitive conditions in the global market for electronic fiberglass materials have remained intense, impacting sales volumes and margins to a greater extent than the company previously expected. Electronics market competitive conditions resulting from the Asian economic situation are also impacting the performance of Hexcel’s joint ventures in Europe and Japan, reducing the amount of equity income that the company recognizes for these joint ventures in its financial statements. As a result, despite higher net sales than in the fourth quarter of 1998, profitability in the first quarter of 1999 is anticipated to be lower than that in the prior quarter.

Also during the first quarter of 1999, Hexcel has continued the consolidation and integration of its global reinforcement materials operations. On March 16, 1999, Hexcel expanded these actions, announcing its plan to close its Cleveland, Georgia manufacturing facility. As a result, the company anticipates recording in its first quarter financial statements approximately $3 million of business acquisition and consolidation charges, primarily reflecting the costs of closing this facility, of which $1.8 million will be non-cash charges. A further charge related to this plant closure of about $1 million is anticipated in the second and/or third quarter of 1999. Hexcel remains focused on improving performance by continuing to reduce costs and improving productivity through its Lean Enterprise initiatives. The company has substantially completed the business consolidation actions that it announced in the fourth quarter of 1998 and continues to seek further opportunities to eliminate cost.

B u s i n e s s   A c q u i s i t i o n s

Over the last three years, the company has substantially expanded its size, through both internal growth as well as through acquisitions. During 1998, 1997 and 1996, the company acquired:

• certain assets and assumed certain operating liabilities of the industrial fabrics business from Clark-Schwebel, Inc. and its subsidiaries’ (“Clark-Schwebel”) on September 15, 1998, including interests in three joint ventures, one of which was acquired in December 1998 (the “Acquired Clark-Schwebel Business”);
• the worldwide composites division of Ciba, including most of Ciba’s composite materials, parts and structures businesses, on February 29, 1996. The company subsequently acquired Ciba’s Austrian composites business on May 30, 1996, and various remaining assets of Ciba’s worldwide composites division at various dates through February 28, 1997 (the “Acquired Ciba Business”);
• the composite products division of Hercules Incorporated including Hercules’ carbon fibers and prepreg businesses, on June 27, 1996 (the “Acquired Hercules Business”); and
• the satellite business and rights to certain technologies from Fiberite, Inc., on September 30, 1997.

All of the above acquisitions were accounted for under the purchase method of accounting. Accordingly, the consolidated balance sheets, statements of operations, stockholders’ equity, and cash flows include the financial position, results of operations and cash flows of the businesses acquired as of such dates and for such periods that these businesses were owned by Hexcel.

Acquired Clark-Schwebel Business
On September 15, 1998, the company acquired certain assets and assumed certain operating liabilities from Clark-Schwebel. The Acquired Clark-Schwebel Business is engaged in the manufacture and sale of high-quality fiberglass fabrics, which are used to make printed circuit boards (“PCBs”) for electronic equipment such as computers, cellular telephones, televisions and automobiles. The Acquired Clark Schwebel Business also produces high performance specialty products for use in insulation, filtration, wall and façade claddings, soft body armor and reinforcements for composite materials. The Acquired Clark-Schwebel Business currently operates four manufacturing facilities in the southeastern US and has approximately 1,300 full time employees. As part of this acquisition, Hexcel also acquired Clark-Schwebel’s equity ownership interests in the following three joint ventures, which are incorporated using the equity method of accounting:

• a 43.6% share in CS-Interglas AG (“CS-Interglas”), headquartered in Germany, together with fixed-price options to increase this equity interest to 84.0%. Hexcel’s acquisition of the CS-Interglas equity interest and related options was completed on December 23, 1998;
• a 43.3% share in Asahi-Schwebel Co., Ltd. (“Asahi-Schwebel”), headquartered in Japan, which in turn has its own joint venture with AlliedSignal Inc. in Taiwan; and
• a 50.0% share in Clark-Schwebel Tech-Fab Company (“CS Tech-Fab”), headquartered in the United States.

CS-Interglas and Asahi-Schwebel are fiberglass fabric producers serving the European and Asian electronics and telecommunications industries. CS Tech-Fab manufactures non-woven materials for roofing, construction and other specialty applications. The fixed-price options to increase the equity interest in CS-Interglas revenues are, in the company’s opinion, significantly higher than their fair market value. Accordingly, the company does not currently anticipate exercising the options, at the stated price, before their expiration on December 31, 1999. The unconsolidated revenues in 1998 for these joint ventures were in excess of $300 million.

The acquisition of the Acquired Clark-Schwebel Business was completed pursuant to an Asset Purchase Agreement dated July 25, 1998, as amended, by and among Hexcel, Stamford CS Acquisition Corp., and Clark-Schwebel (the “Asset Purchase Agreement”). Under the Asset Purchase Agreement, Hexcel acquired the net assets of the acquired business, other than certain excluded assets and liabilities, in exchange for approximately $473 million in cash, including the $19.0 million paid on December 23, 1998. Hexcel also agreed to lease $50.0 million of property, plant and equipment used in the acquired business from an affiliate of Clark-Schwebel, pursuant to a long-term lease with purchase options. Refer to “Financial Resources” for a discussion on acquisition financing.

Acquired Ciba Business
Hexcel acquired most of Ciba’s composite materials, parts and structures businesses on February 29, 1996, Ciba’s Austrian composites business on May 30, 1996, and various remaining assets of Ciba’s worldwide composites division at various dates through February 28, 1997. The Acquired Ciba Business is engaged in the manufacture and marketing of reinforcement fabrics and lightweight, high-performance composite materials, parts and structures for commercial aerospace, space and defense, general industrial and recreation markets.

The acquisition of the Acquired Ciba Business was consummated pursuant to a Strategic Alliance Agreement dated as of September 29, 1995, among Ciba and Hexcel, as amended (the “Strategic Alliance Agreement”). Under the Strategic Alliance Agreement, the company acquired the assets (including the capital shares of certain non-U.S. subsidiaries) and assumed the liabilities of the Acquired Ciba Business, other than certain excluded assets and liabilities, in exchange for: (a) 18,022 newly issued shares of Hexcel common stock; (b) $25.0 million in cash; (c) senior subordinated notes in an aggregate principal amount of $37.5 million, with a fair value of $34.5 million; and (d) senior demand notes in an aggregate principal amount equal to the cash on hand at certain of the non-U.S. Subsidiaries included in the Acquired Ciba Business. The total aggregate purchase price for the net assets acquired was approximately $209 million.

Acquired Hercules Business
Hexcel acquired the assets of the composite products division of Hercules on June 27, 1996. The Acquired Hercules Business, which manufactures carbon fibers and prepregs for commercial aerospace, space and defense, general industrial and recreation markets, was purchased for $139.4 million in cash.

Acquired Fiberite Assets
On September 30, 1997, the company acquired from Fiberite its satellite business consisting of intangible assets and inventory, and certain non-exclusive worldwide rights to other prepreg technologies, for $37.0 million in cash. The acquisition was substantially downsized from the original agreement whereby the company had, subject to certain terms and conditions, committed to purchase selected assets and businesses of Fiberite for approximately $300 million. As a result of the downsized transaction, the company wrote-off $5.0 million of acquisition and financing costs to business acquisition and consolidation expenses in 1997. In addition, the company expensed $8.0 million of acquired in-process research and technology purchased from Fiberite which is included in the 1997 business acquisition and consolidation expenses. Substantially all of the $37.0 million purchase price, less the $8.0 million write-off of the acquired in-process research and technology, was allocated to intangible assets.

Further discussion and analysis of the company’s business acquisitions is contained in Notes 1, 2 and 3 to the accompanying consolidated financial statements.

R e s u l t s   o f   O p e r a t i o n s

1998 Compared to 1997
NET SALES: Net sales for 1998 were $1,089.0 million, compared with net sales for 1997 of $936.9 million. The results for 1998 include the results of the Acquired Clark-Schwebel Business from the date of acquisition, September 15, 1998, through December 31, 1998. Excluding the results of the Acquired Clark-Schwebel Business, 1998 sales were approximately $1,030.6 million, a 10% increase over 1997. The sales growth was primarily due to strong sales of composite products to the commercial aerospace market, primarily in Europe, as well as to the space and defense markets. On a constant currency basis, 1998 sales would not have been materially different than reported.

Pro forma net sales for 1998 and 1997 by product group and market segment, after giving effect to the acquisition of the Acquired Clark-Schwebel Business as if the transaction had occurred at the beginning of the year, were as follows:

The 14% growth in pro forma net sales to the commercial aerospace market from 1997 to 1998 was largely attributable to increased sales of composite materials and reflects the increase in commercial aircraft build rates by the company’s two largest customers, The Boeing Company (“Boeing”) and Airbus Industrie (“Airbus”). The increase also reflects an improvement in the engineered products segment’s shipments of retrofit interiors to airline customers.

Approximately 35% and 36% of Hexcel’s 1998 and 1997 net sales, respectively, were identifiable as sales to Boeing and related subcontractors. Of the 35% of sales attributable to Boeing and its subcontractors, 32% and 3% related to commercial aerospace and space and defense market applications, respectively. Approximately 11% and 10% of Hexcel’s 1998 and 1997 net sales, respectively, were identifiable as sales to Airbus and related subcontractors. Reported commercial aircraft deliveries by Boeing and Airbus improved significantly in 1998, from a combined 557 aircraft in 1997 to 788 aircraft in 1998, including 559 and 229 deliveries from Boeing and Airbus, respectively. Depending on the product, orders placed with Hexcel are received anywhere between one and eighteen months prior to delivery of the aircraft to the customer. The company sells material for every model of commercial aircraft sold by Boeing and Airbus, with sales per aircraft ranging from $0.2 million to over $1.0 million. Based on published projections, combined deliveries for Boeing and Airbus are expected to peak at 913 in 1999, before declining to approximately 800 in 2000. As the company supplies its products ahead of the delivery of a commercial aircraft, it will start to see the impact of reduced Boeing production rates by summer 1999. The company’s sales to regional and general aviation aircraft manufacturers remain robust.

During 1998, the company’s commercial aerospace customers started emphasizing the need for material yield improvement and cost and inventory reduction throughout the industry’s supply chain. In response to these pressures, the company reduced the price of certain products in 1999. Further, the company is aware that one customer is planning, in the third quarter of 1999, to substitute one of Hexcel’s premium products for a lower cost, lower priced alternative product, which will also be provided by Hexcel. Although these changes impact the company’s profit margins, the company’s various cost reduction and efficiency improvement programs are focused on mitigating the impact in whole or in part. Meanwhile the company’s sales of products used to retrofit aircraft interiors continue to grow with a strong initial reception for its kit product which extends the size of overhead stowage bins in narrow aisle aircraft.

Taking all of the above factors into account, the company currently anticipates that its net sales to the commercial aircraft market will show a moderate reduction in 1999 compared to 1998 pro forma net sales, with the greater impact being seen in the second half of the year.

Space and defense pro forma net sales increased 44% from 1997 to 1998, reflecting an increase in sales of reinforcement products and composite materials to select military and space programs, as well as the company’s acquisition of Fiberite’s satellite business on September 30, 1997. The company currently anticipates that its net sales to space and defense applications will grow in 1999 over 1998 pro forma net sales, but not as rapidly as was seen in 1998.

In the last quarter of 1998, the company experienced cancellations of certain carbon fiber orders. The company believes that, in response to a significant shortage of carbon fiber supply in 1997, a number of the company’s customers, particularly those in the space and defense market, purchased and/or ordered more carbon fiber than they needed during 1997 and 1998. Now that carbon fiber supplies are more certain, customers are reducing their inventories and are therefore anticipating lower purchasing needs for 1999. These factors resulted in surplus inventories throughout the supply chain, including Hexcel, at December 31, 1998 and a significant reduction in the anticipated carbon fiber production for 1999 as compared to 1998. The increase in worldwide carbon fiber capacity limits both the company’s ability to sell its short-term excess capacity to other markets and prices at which such surplus capacity can be sold.

Despite these short-term impacts, the company still anticipates growth in carbon fiber sales in 2000 and beyond as new military aircraft and launch vehicle programs, in both the US and Europe, enter full-scale production. The military market uses a higher percentage of advanced structural materials and higher value products than the commercial market. The company is currently qualified to supply materials to a broad range of military aircraft and helicopters scheduled to enter full-scale production at the start of the next decade. These programs include V-22 (Osprey) tilt-roter, F-22 (Raptor), F/A-18E/F (Hornet), C-17 transport, European Fighter Aircraft (Typhoon), RAH-66 (Comanche) and NH90 helicopter.

Pro forma electronics net sales decreased 12% from 1997 to 1998. In the second and third quarters of 1998, the electronics industry, including the company, experienced a worldwide reduction in sales volume, primarily resulting from inventory adjustments across the supply chain. Towards the end of the third quarter and into the fourth quarter of 1998, the company experienced increased order volume for woven fiberglass products used in electronic PCB applications, suggesting an end to the inventory correction. However, intense competition from manufacturers located in Asia continues to place pressure on volumes and prices for these products. In light of market uncertainties, the company can not predict as to when these conditions in the electronic market for woven fiberglass products may recover and therefore continues to pursue opportunities to reduce the cost of its products and enhance its ability to compete effectively. The company has been successful in partially offsetting these price reductions by obtaining lower raw material prices. Nevertheless, the company anticipates that its electronic net sales in 1999 will be less than 1998 pro forma net sales.

Pro forma general industrial net sales for advanced structural materials decreased 16% from 1997 to 1998, primarily reflecting a reduction in the level of soft body armor sales to various government agencies. Nevertheless, the company anticipates that net sales to certain of the emerging markets for the company’s products accumulated in the general industrial market will continue to grow in 1999 compared to 1998 pro forma net sales, with growth opportunities coming from ground transportation, architectural and civil engineering, wind energy and soft body armor applications. This growth is currently anticipated to offset the reduction in net sales in the commercial aerospace market.

Pro forma recreation net sales decreased 15% from 1997 to 1998, reflecting reduced customer demand for certain products in this market, including, one particular customer who is changing the design of many of its athletic shoes to alternative materials. The company currently anticipates that its 1999 recreation market revenues will be at the same level as 1998.

Backlog for aerospace materials was $452.1 million as of December 31, 1998, a 5% decrease over backlog as of December 31, 1997. The decrease in backlog reflects a number of factors, including a continuing trend toward shorter lead times and better supply-chain management by the industry overall. In light of changing conditions in the aerospace industry, twelve month backlog information may no longer be a meaningful trend indicator. The company continues to closely watch the economic situation in Asia, along with overall aircraft orders and production trends, to monitor future sales.

Backlog for the non-aerospace markets was $41.0 million as of December 31, 1998, compared to $43.5 million as of December 31, 1997. The decrease in backlog is primarily attributable to a decrease in orders from customers in the recreation market. Customers in the electronics, general industrial and recreation markets generally operate with little advance purchasing and thus, backlog is subject to certain fluctuations. The Acquired Clark-Schwebel Business also operates with nominal backlog. The company’s backlog in the non-aerospace markets for the next twelve months is therefore not necessarily a meaningful indicator of future sales.

GROSS MARGIN: Gross margin for 1998 was $271.3 million, or 24.9% of net sales, compared with $222.6 million, or 23.8% of net sales, for 1997. Excluding the Acquired Clark-Schwebel Business, 1998 gross margin was also 24.9%. The improvement in 1998 gross margin relative to 1997 is the result of higher sales volume and the benefit from the company’s 1996 consolidation and restructuring program. While gross margin for 1998 increased over 1997, on a quarterly trend basis, the company’s gross margin percentage has leveled off as the company’s 1996 business consolidation program has approached completion and commercial aerospace growth has flattened. The company is, however, pursuing efforts to reduce its cost structure and increase its productivity through its Lean Enterprise program, which was extended to all US locations in the latter part of 1998 and which will be extended to its European facilities in 1999. The expected improvements in cost and productivity will be offset by customer demand for reductions in the costs of the products that they purchase from the company.

SELLING, GENERAL AND ADMINISTRATIVE (“SG&A”) EXPENSES: SG&A expenses were $117.9 million in 1998, or 10.8% of net sales. This compared to $102.4 million, or 10.9% of net sales for 1997. The aggregate dollar increase in SG&A was primarily attributable to the increased sales volume in commercial aerospace and the Acquired Clark-Schwebel Business.

RESEARCH AND TECHNOLOGY (“R&T”) EXPENSES: R&T expenses were $23.6 million in 1998, or 2.2% of net sales. This compared to $18.4 million, or 2.0% of net sales for 1997. The aggregate dollar increase in R&T was attributable to additional expenditures in 1998 resulting from an increased commitment to R&T activities and, to a lesser extent, the Acquired Clark-Schwebel Business.

OPERATING INCOME: Operating income increased from $76.5 million, or 8.2% of net sales, in 1997 to $117.0 million, or 10.8% of net sales, in 1998. The aggregate increase in operating income reflects the higher sales volume, improved gross margins, a $12.6 million decrease in business acquisition and consolidation expenses and $7.6 million from the Acquired Clark-Schwebel Business. Excluding business acquisition and consolidation expenses, operating income as a percentage of sales increased from 10.9% in 1997 to 11.9% in 1998.

INTEREST EXPENSE: Interest expense was $38.7 million, or 3.6% of net sales, for 1998 compared to $25.7 million, or 2.7% of net sales, for 1997. The increase in interest expense was primarily due to the additional financing required for the Acquired Clark-Schwebel Business as well as working capital needs, and a $1.6 million write-off of capitalized loan fees relating to the company’s previous credit facilities.

PROVISION FOR INCOME TAXES: The effective income tax rate for 1998 was 36%. For the year ended December 31, 1997, the benefit for income taxes was $22.9 million, which included a $39.0 million reversal of a US tax valuation allowance.

Prior to September 30, 1997, the company had fully provided valuation allowances against its US net deferred tax assets as there were uncertainties regarding the company’s ability to generate sufficient future taxable income to realize these net deferred tax assets. On September 30, 1997, the company reversed its US tax valuation allowance as it was more likely than not that these tax assets would be realized. As a result, excluding the $39.0 million US valuation allowance reversal, no provision for US federal income taxes had been recorded for the first nine months of 1997 due to the utilization of net operating loss carryforwards. The company continues to reserve the balance of the net deferred tax assets of its Belgium operations.

NET INCOME: Net income for 1998 was $50.4 million or $1.24 per diluted share compared with $73.6 million or $1.74 per diluted share for 1997. As part of the Acquired Clark-Schwebel Business, net income for 1998 includes $0.5 million of equity in earnings from affiliated companies. Pro forma net income, after giving effect to the acquisition of the Acquired Clark-Schwebel Business as if the transaction had occurred at the beginning of the year, was $49.5 million. Excluding business acquisition and consolidation expenses of $12.7 million and $25.3 million in 1998 and 1997, respectively, and assuming a US effective income tax rate of 36% in 1997, net income would have been $1.43 and $1.17 per diluted share in 1998 and 1997, respectively.

As of December 31, 1998 and 1997, there were 36.3 million and 36.9 million shares of Hexcel common stock outstanding, respectively. See Note 13 to the accompanying consolidated financial statements for the calculation, including the number of shares used, of diluted net income per share.

1997 Compared to 1996
NET SALES: Net sales for 1997 were $936.9 million, compared with net sales for 1996 of $695.3 million. On a pro forma basis, including full year results of the Acquired Ciba and Hercules Businesses, 1996 sales were approximately $798.5 million. The 17% increase from pro forma 1996 sales was largely attributable to improved sales of composite materials to commercial aerospace customers and sales of engineered products to Boeing. This increase was partially offset by the translation effect of the strengthening US dollar. On a constant currency basis, 1997 sales would have been approximately $38.0 million higher, reflecting a 22% increase over 1996 pro forma sales.

Approximately 46% of Hexcel’s 1997 sales were to Boeing, Airbus, and related subcontractors, as compared to 32% in 1996. The increase is primarily due to the growth of the commercial aerospace market and to a much lesser extent Boeing’s acquisition of McDonnell Douglas Corporation, which was completed on August 1, 1997. Reported commercial aircraft deliveries by Boeing and Airbus improved significantly in 1997, from a combined 397 aircraft in 1996 to 557 aircraft in 1997, including 375 from Boeing and 182 deliveries by Airbus. As previously discussed, depending on the product, orders placed with Hexcel are received anywhere between one and eighteen months prior to delivery of the aircraft to the customer. The company sells material for every model of commercial aircraft sold by Boeing and Airbus, with sales per aircraft ranging from $0.2 million to over $1.0 million per aircraft on the Boeing 777.

Net sales to third-party customers by product group and market segment for 1997 and on a pro forma basis for 1996, which includes full year results of the Acquired Ciba and Hercules Businesses, are presented below. These net sales and pro forma net sales, excluding the effects of the Acquired Clark-Schwebel Business were:

The 37% growth in net sales to the commercial aerospace market from 1996 to 1997 was largely attributable to increased sales of composite materials and engineered products. The improvement in sales of composite materials reflects the commercial aircraft build rate increase noted above. The improvement for engineered products primarily reflects the production of structural and interior components outsourced to Hexcel by Boeing throughout 1997, as well as strong shipments of retrofit interiors to airline customers.

Space and defense net sales decreased 3% from 1996 to 1997, reflecting a decrease in sales of reinforcement products, which were partially offset by improved sales of composite materials to select military programs.

Electronics net sales in 1996 were comparable to 1997. The 3% increase in general industrial net sales was largely due to improved sales of composite materials for various transportation applications. Recreation net sales decreased 27% from 1996 to 1997, reflecting the shift in emphasis of production to the commercial aerospace market as a result of the increased demand. Hexcel anticipated sales to the electronics, general industrial and recreation markets to grow modestly throughout 1998.

GROSS MARGIN: Gross margin for 1997 was $222.6 million, or 23.8% of net sales, compared with $141.3 million, or 20.3% of net sales, for 1996. The improvement in 1997 gross margin relative to 1996 was the result of higher sales volume, expansion of the company’s fibers capacity and continued advances in manufacturing productivity resulting from the company’s consolidation and restructuring activities. Product price changes were not a significant factor in the 1997 gross margin improvement.

The integration of the Acquired Ciba and Hercules Businesses into Hexcel, including the consolidation and rationalization of manufacturing facilities and processes, is a primary objective of the business consolidation program. While the company began to realize the productivity improvements in 1997 as a result of the program, these improvements will not be fully realized until 1999.

SELLING, GENERAL AND ADMINISTRATIVE (“SG&A”) EXPENSES: SG&A expenses were $102.4 million in 1997, or 10.9% of net sales. This compares to $79.4 million, or 11.4% of net sales for 1996. The aggregate dollar increase in SG&A was primarily attributable to the Acquired Ciba and Hercules Businesses.

RESEARCH AND TECHNOLOGY (“R&T”) EXPENSES: R&T expenses were $18.4 million in 1997, or 2.0% of net sales. This compared to $16.7 million, or 2.4% of net sales for 1996. The aggregate dollar increase in R&T was attributable to the additional activity from the Acquired Ciba and Hercules Businesses.

OPERATING INCOME: Operating income increased from $2.8 million, or 0.4% of net sales, in 1996 to $76.5 million, or 8.2% of net sales, in 1997. The aggregate increase in operating income reflects the higher sales volume, improved gross margins and a $17.0 million decrease in business acquisition and consolidation expenses. Excluding business acquisition and consolidation expenses, operating income as a percentage of sales increased from 6.5% in 1996 to 10.9% in 1997.

INTEREST EXPENSE: Interest expense was $25.7 million, or 2.7% of net sales, for 1997 compared to $21.5 million, or 3.1% of net sales, for 1996. The increase in interest expense primarily represents the cost of financing the acquisitions of the Acquired Ciba and Hercules Businesses. The 1996 amount also includes a $3.4 million write-off of capitalized debt issuance costs.

PROVISION FOR INCOME TAXES: As previously discussed, in 1997 the company reversed $39.0 million of its US valuation allowance reserves in accordance with SFAS 109. Prior to 1997, the company had fully provided valuation allowance reserves against its net deferred tax assets in the US and Belgium where there were uncertainties in generating sufficient future taxable income.

NET INCOME (LOSS): Net income for 1997 was $73.6 million or $1.74 per diluted share compared with a net loss of $19.2 million or $0.58 per diluted share for 1996. Excluding the $25.3 million in business acquisition and consolidation expenses and assuming a US effective income tax rate of 36%, 1997 adjusted net income would have been $1.17 per diluted share. Pro forma net income for 1996 would have been $0.48 per diluted share on a comparable basis.

There were 36.7 million weighted average shares outstanding in 1997 compared to 33.4 million during 1996. The increase in the number of weighted average shares in 1997 was primarily attributable to the full year impact of the delivery of 18.0 million newly issued shares of Hexcel common stock to Ciba on February 29, 1996 in connection with the purchase of the Acquired Ciba Business. As of December 31, 1997, there were 36.9 million shares of Hexcel common stock issued and outstanding. See Note 13 to the accompanying consolidated financial statements for the calculation, including the number of shares used, of diluted net income per share.

(continued)

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