F i n a n c i a l C o n d i t i o n a n d L i q u i d i t y
On January 21, 1999, the company issued $240.0 million of Senior Subordinated Notes. Net proceeds of approximately $231 million from this offering were used to repay amounts owed under the Senior Credit Facility. Simultaneously with the closing of this offering, the company amended the Senior Credit Facility to, among other things, reduce the available borrowing capacity to $672.0 million, modify certain financial covenants and to permit the offering. On February 17, 1999, the company also redeemed $12.5 million of its increasing rate senior subordinated notes payable to Ciba. Such repayment was financed with borrowings under the company’s Senior Credit Facility. The company anticipates making further redemptions as it generates free cash flow.
In connection with the purchase of the Acquired Hercules Business in 1996, Hexcel obtained a revolving credit facility (the “Revolving Credit Facility”). The Revolving Credit Facility was obtained to: (a) refinance outstanding indebtedness under a senior secured credit facility; (b) finance the purchase of the Acquired Hercules Business; and (c) provide for the ongoing working capital and other financing requirements of the company, including business consolidation activities, on a worldwide basis. The Revolving Credit Facility was amended in March 1998 (the “Amended Revolving Credit Facility”) and in September 1998, the Senior Credit Facility replaced the Amended Revolving Credit Facility. The Amended Revolving Credit Facility, prior to its replacement, had provided up to $355.0 million of borrowing capacity and would have expired in March 2003.
The company expects that its financial resources, including the Senior Credit Facility, will be sufficient to fund the company’s worldwide operations for the foreseeable future. Nonetheless, one of the company’s primary goals over the next few years is generating operating cash flow to reduce debt, including reducing working capital. Further discussion of the company’s financial resources is contained in Note 7 to the accompanying consolidated financial statements.
Capital Lease Obligation
Stock Buyback Plans
Other Capital Commitments
The company has total estimated financial commitments to its proposed joint ventures in China and Malaysia of approximately $31 million. These commitments are expected to be made in increments through 2001.
Cash Flows and Ratio of Earnings to Fixed Charges
Net cash used for investing activities was $539.2 million, reflecting $472.8 million of net cash paid for the Acquired Clark-Schwebel Business, and $66.5 million of capital expenditures. Net cash provided by financing activities was $440.7 million, primarily reflecting $459.7 million of net funds borrowed under the Senior and Revolving Credit Facilities, including the financing of the Acquired Clark-Schwebel Business, offset in part by the repurchase of $10.0 million of treasury stock and $10.3 million of debt issuance costs related to the Senior and Amended Revolving Credit Facilities.
1997: Adjusted EBITDA for 1997 was $137.6 million and pro forma Adjusted EBITDA was $188.3 million. Net cash provided from operations was $29.2 million including $33.6 million of business acquisition and consolidation payments and a $46.7 million increase in working capital as a result of the increase in sales volume.
Net cash used for investing activities was $82.9 million, including $57.4 for capital expenditures and $37.0 million for the Fiberite transaction, partially offset by $13.5 million of proceeds from the sale of the Anaheim facility and the company’s 50% interest in the Knytex joint venture to Owens Corning. These investing activities were funded by cash from operations and $57.2 million of borrowings primarily under the Revolving Credit Facility.
1996 : Adjusted EBITDA was $71.9 million. Pro forma Adjusted EBITDA, giving effect to the acquisitions of the Acquired Ciba and Hercules Businesses as if those transactions had occurred at the beginning of the year, was approximately $86 million.
Net cash provided by operating activities was $33.8 million. Net cash used for investing activities was $206.4 million, including $164.4 million used in connection with the acquisitions of the Acquired Ciba and Hercules Businesses and $43.6 million for capital expenditures. Net cash provided by financing activities, including borrowings under the Revolving Credit Facility and proceeds from the issuance of $114.5 million in convertible subordinated notes, was $174.4 million. Non-cash financing of the purchase of the Acquired Ciba Business included the issuance of debt securities valued at $37.2 million and the issuance of 18.0 million shares of Hexcel common stock valued at $144.2 million.
Adjusted EBITDA and pro forma Adjusted EBITDA have been presented to provide a measure of Hexcel’s operating performance that is commonly used by investors and financial analysts to analyze and compare companies. Adjusted EBITDA may not be comparable to similarly titled financial measures of other companies. Adjusted EBITDA and pro forma Adjusted EBITDA do not represent alternative measures of the company’s cash flows or operating income, and should not be considered in isolation or as substitutes for measures of performance presented in accordance with generally accepted accounting principles. A reconciliation of net income to EBITDA and Adjusted EBITDA for 1998, 1997 and 1996 is as follows:
The ratio of earnings to fixed charges for 1998 and 1997 was 2.9. In 1996, the deficiency of earnings to fixed charges was $15.8 million. The calculation of earnings to fixed charges assumes that one-third of the company’s rental expense, representing a reasonable approximation of such rentals, is attributable to interest expense.
B u s i n e s s C o n s o l i d a t i o n P r o g r a m s
In December 1998, Hexcel announced consolidation actions within its reinforcement fabrics and composite materials businesses. These actions included the integration of Hexcel’s existing fabrics business with the U.S. operations of the Acquired Clark-Schwebel Business, and the combination of the company’s US, European and Pacific Rim composite materials businesses into a single, global business unit. These actions are intended to eliminate redundancies, improve manufacturing planning, and enhance customer service, and resulted in the elimination of approximately 100 operating, sales, marketing and administrative positions. The cost of these actions, together with a $6.4 million non-cash charge for writing down certain assets held for disposition and another $0.7 million incurred for costs related to a proposed acquisition that was not consummated, resulted in the recognition of $12.7 million in business acquisition and consolidation expenses in 1998. Beginning in 1999, the company anticipates annual cash savings from these business consolidation activities to be approximately $10 million.
In addition to these initiatives, the company expects to complete a global capacity review of its worldwide facilities requirements during 1999. On March 16, 1999, the company announced the closing of its Cleveland, Georgia facility, which currently employs 100 people and produces fabrics for the electronics market. Production equipment from the facility will be relocated to the company’s Anderson, S.C. facility, with the closure expected to be completed by July 1, 1999. Anticipated cash savings from this business consolidation activity will help offset competitive pricing pressures in the company’s electronics market. In addition to this facility closure, the global capacity review may result in the closing or right-sizing of additional facilities and, as a result, additional consolidation charges will be recognized in 1999.
In 1996, Hexcel announced plans to consolidate the company’s operations over a period of three years. The objective of the program was to integrate acquired assets and operations into Hexcel, and to reorganize the company’s manufacturing and research activities around strategic centers dedicated to select product technologies. The business consolidation program was also intended to eliminate excess manufacturing capacity and redundant administrative functions. Specific actions of the consolidation program included the elimination of 245 manufacturing, marketing and administrative positions, the closure of the Anaheim, California facility acquired in connection with the purchase of the Acquired Ciba Business (the building was sold in 1997 for net proceeds of approximately $8.5 million), the reorganization of the company’s manufacturing operations in Europe, the consolidation of the company’s US special process manufacturing activities, and the integration of sales, marketing and administrative resources. Management expected that this consolidation program would take approximately three years to complete, in part because of the aerospace industry requirements to “qualify” specific equipment and manufacturing facilities for the manufacture of certain products. These qualification requirements increase the complexity, cost and time of moving equipment and rationalizing manufacturing activities.
As of December 31, 1998, the primary remaining activities of this consolidation program relate to the company’s European operations and certain customer qualifications of equipment transferred within the US The company expects that activities related to this consolidation program will be completed in 1999. Total expenses for this program, which remains unchanged since December 31, 1997, were $54.7 million, excluding $13.0 million of expenses relating to the Fiberite transaction, which were not included in the original program. The company anticipates no additional expenses in relation to this consolidation program.
The company initially estimated that 1996 business consolidation program would result in annual cost reductions of $32 million per year, beginning in 1999. Due to the nature of the program (i.e., consolidation of existing and acquired businesses, while at the same time the company was experiencing an increase in its commercial aerospace market), the exact amount of annual savings is difficult to isolate. However, the company continues to believe that cost savings have been achieved and, upon completion of the program, estimated cost savings will equal or exceed the target of $32 million per year. The program was a key contributor to the company’s improvement in operating margins in 1997 and 1998.
Further discussion and analysis of the company’s business consolidation programs is contained in Note 3 to the accompanying consolidated financial statements.
M a r k e t R i s k s
The company’s financial position, results of operations and cash flows are subject to market risks, which primarily include fluctuations in interest rates and exchange rate variability.
The table below presents the impact on the company’s net income and pro forma net income, as if the acquisition of the Acquired Clark-Schwebel Business had occurred at the beginning of the year and, after adjusting interest expense for the above refinancings, of a 10% favorable and a 10% unfavorable change in the company’s variable rate debt:
The primary currencies for which the company has foreign currency translation exchange rate exposure are the US dollar versus the British pound, French franc, German mark, Belgium franc, Austrian schilling and Spanish peseta. With the introduction of the Euro, the company’s primary exposures are now between the US dollar, British pound and the Euro. The company does not participate in hedging activities to offset translation effects of changes in foreign exchange rates on the company’s consolidated financial position, results of operations and cash flows. The impact of a 10% appreciation or 10% depreciation of the US dollar against the company’s net underlying foreign currency translation exposures could be significant.
Y e a r 2 0 0 0 R e a d i n e s s D i s c l o s u r e
Hexcel, like most other companies, is continuing to address whether its information technology systems and non-information technology devices with embedded microprocessors (collectively “Business Systems and Devices”) will recognize and process dates starting with the year 2000 and beyond (the “Year 2000”). The Year 2000 issue can arise at any point in the company’s supply, manufacturing, processing and distribution chains. The company does not, however, manufacture or sell products that contain microprocessors or software.
The company has established a central Year 2000 project office to coordinate and monitor progress towards achieving corporate-wide Year 2000 compliance. A discussion of the company’s Business Systems and Devices, suppliers and vendors as they pertain to the company’s Year 2000 issues, as of February 28, 1999, is detailed as follows:
Systems & Devices
(I) INVENTORY: This phase, which was completed in December 1998, consisted of compiling a detailed listing of the company’s Business Systems and Devices likely to be impacted by the Year 2000 issue.
(II) RISK ASSESSMENT AND ASSIGNING PRIORITIES: This phase consisted of assessing the likelihood that a Business System or Device is not Year 2000 compliant as well as assigning a priority of importance to the particular Business System or Device as it relates to the company’s business operations. This phase was completed in December 1998.
(III) ASSESSING COMPLIANCE: This phase consists of assessing Year 2000 compliance on the company’s Business Systems or Devices which have been identified as essential to the company’s business operations. In assessing compliance, the company performs a variety of tasks including, obtaining Year 2000 compliance statements and information from the company’s vendors and service providers. This phase is substantially complete, with final completion estimated by March 31, 1999. However, in order to complete this phase, the company is dependent upon the cooperation from its suppliers and service providers as well as the completeness and accuracy of their responses.
(IV) REPAIRING OR REPLACING: This phase consists of repairing and replacing non-Year 2000 compliant Business Systems and Devices which are essential to the company’s operations. This phase is approximately 50% complete, with substantial completion estimated by June 30, 1999.
(V) TESTING: This phase consists of testing the repair or replacement of those Business Systems and Devices which are essential to the company’s business operations. The company also intends to test the integration of the various Business Systems and Devices within the company’s manufacturing processes. This phase is approximately 45% complete, with substantial completion estimated by June 30, 1999. The results of this phase may change the estimated timing of completion of phase four.
(VI) DEVELOPING CONTINGENCY PLANS: This phase consists of developing alternative plans in the event that a business interruption occurs from a Year 2000 issue. The company is in the early stages of this phase. The company has targeted September 30, 1999 as the date of substantially completing its contingency plans, however, the company believes that this phase will be ongoing through to the year 2000.
Suppliers & Customers The company is also monitoring the status of its significant suppliers and customers as a means of assessing risks and developing alternatives. The company has sent out surveys to all of its significant suppliers and customers to determine what steps, if any, those companies are taking to remediate their respective Year 2000 issues. The company is, however, dependent upon its suppliers and customers with respect to the completeness and accuracy of such responses.
As of February 28, 1999, the company has received responses from nearly two-thirds and one-third of its significant suppliers and customers, respectively. The responses from the company’s suppliers generally indicate that these parties are taking actions to ensure that their ability to supply products or services to the company will not be impaired. To the extent that supplier responses to Year 2000 readiness are unsatisfactory, the company will attempt to reduce risks of interruptions, with such options including changes in suppliers to those who have demonstrated Year 2000 readiness, and accumulation of inventory. The responses from the company’s customers also generally indicate that these parties are taking actions to ensure their ability to purchase products from the company will not be impaired. The company will continue to monitor the status of all of its significant suppliers’ and customers’ Year 2000 readiness through to the year 2000, in order to determine whether additional or alternative measures are necessary.
Total estimated costs to address the company’s Year 2000 issues, including preparing the company’s Business Systems and Devices to become Year 2000 compliant, is approximately $5.5 million, of which approximately $1.5 million has been incurred as of February 28, 1999. The total estimated cost includes approximately $1 million of capital expenditures to be used for the purchase of certain capital equipment to replace equipment which is currently not Year 2000 compliant. The estimate also includes the cost of certain internal resources fully dedicated to this project, however, it does not include any costs associated with the implementation of contingency plans, which have not yet been developed. The company has not used any external resources to independently verify these cost estimates. Due to resource constraints caused by the Year 2000 issue, the company is deferring other information technology projects. These deferrals, however, are not expected to have a material adverse effect on the company’s results of operations or financial condition.
As the company has not yet developed its contingency plans (these plans are expected to be completed by September 30, 1999), it is unable to assess the most reasonably likely worst case scenario. However, if necessary remediation actions are not completed in a timely manner, or if the company’s suppliers and customers do not successfully address their Year 2000 issues, the company estimates that a disruption in operations could occur. Such a disruption could result in, for example, delays in the receipt of raw materials and distribution of finished goods, or errors in customer orders. These consequences could have a material impact on the operations, liquidity and financial condition of the company. The company presently believes that by implementing its plans, including modifications to existing Business Systems and Devices and conversion to new or upgraded software and other systems, the Year 2000 issue will not pose significant operational problems for the company.
R e c e n t l y I s s u e d A c c o u n t i n g S t a n d a r d
In June 1998, the Financial Accounting Standards Board issued Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). This Statement requires companies to record derivatives on the balance sheet as assets and liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS 133 is not expected to have a material impact on Hexcel’s consolidated financial statements. This Statement is effective for fiscal years beginning after June 15, 1999. Hexcel will adopt this accounting standard as required by January 1, 2000.
F o r w a r d - L o o k i n g S t a t e m e n t s a n d R i s k F a c t o r s
This annual report includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information which 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,” “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) estimates of commercial aerospace production and delivery rates, including those of Boeing and Airbus; (b) estimates of the change in net sales in total and by market compared to 1998 pro forma net sales; (c) expectations regarding the growth in the production of military aircraft and launch vehicle programs in 2000 and beyond; (d) expectations regarding the impact of pricing pressures from Hexcel’s customers; (e) expectations regarding the ability of Hexcel to pass along price reductions to its suppliers; (f) expectations regarding future sales based on current backlog; (g) expectations regarding sales growth, sales mix, gross margins, manufacturing productivity, capital expenditures and treasury stock repurchases; (h) expectations regarding Hexcel’s financial condition and liquidity, as well as future free cash flows and earnings; (i) estimates of the total cost of Hexcel’s 1996 business consolidation program and the likelihood that additional business acquisition and consolidation expenses would be incurred in 1999; (j) expectations regarding the costs and benefits of accelerating and expanding Hexcel’s Lean Enterprise and business consolidation programs, including the closure of the company’s Cleveland, GA facility, and implementing a value chain management program; (k) expectations regarding the exercise of the CS-Interglas options at their stated price; (l) the impact of various market risk fluctuations, including fluctuations in: the company’s variable rate debt; currencies in which the company has translation exposure to; and changes in the market value of the company’s common stock; and; (m) the impact of the Year 2000 issue, the estimated costs associated with becoming Year 2000 compliant and the estimated target date for substantial completion of remediation.
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: the integration of the Acquired Clark-Schwebel Business without disruption to manufacturing, marketing and distribution activities; changes in general economic and business conditions; changes in current pricing levels; changes in political, social and economic conditions and local regulations, particularly in Asia and Europe; foreign currency fluctuations; changes in aerospace delivery rates; reductions in sales to any significant customers, particularly Boeing or Airbus; changes in sales mix; changes in government defense procurement budgets; changes in military aerospace programs technology; industry capacity; competition; disruptions of established supply channels; manufacturing capacity constraints; the availability, terms and deployment of capital; and the ability of Hexcel to accurately estimate the cost of systems preparation and successfully implement required actions for Year 2000 compliance.
If one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect, our actual results may vary materially from those expected, estimated or projected. In addition to other factors that affect the company’s operating results and financial position, past financial performance or the company’s expectations should not be considered to be a reliable indicator of future performance. Investors should not use historical trends to anticipate results or trends in future periods. Further, the company’s stock price is subject to volatility. Any of the factors discussed above could have an adverse impact on the company’s stock price. 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 company’s stock price.
The company does not undertake an obligation to update its forward-looking statements or risk factors to reflect future events or circumstances.