HEXCEL CORP /DE/ - Quarter Report: 2015 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarter Ended September 30, 2015

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  x    No  o

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  x    No  o

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.

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

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

HEXCEL CORPORATION AND SUBSIDIARIES

INDEX

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PART I. FINANCIAL INFORMATION

ITEM 1. Condensed Consolidated Financial Statements (Unaudited)

Hexcel Corporation and Subsidiaries

Condensed Consolidated Balance Sheets

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, 2014 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 a fair statement of financial position, results of operations and cash flows for the interim periods presented. The Condensed Consolidated Balance Sheet as of December 31, 2014 was derived from the audited 2014 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 2014 Annual Report on Form 10-K filed with the SEC on February 5, 2015.

Investments in Affiliated Companies

We have 50% equity ownership investments in an Asian joint venture Aerospace Composites Malaysia Sdn. Bhd. (“ACM”) and in Formax UK Limited (“Formax”).  These investments are accounted for using the equity method of accounting.

Recent Accounting Pronouncements

In August 2015, the Financial Accounting Standards Board (“FASB”) postponed Accounting Standard Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers until 2018. The update clarifies the principles for recognizing revenue and develops a common revenue standard for all industries. Early application is permitted in 2017 for calendar year entities. We are currently evaluating the impact of adopting this prospective guidance on our consolidated results of operations and financial condition.

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The guidance is effective January 1, 2016 with early adoption permitted. The Company adopted this update in the third quarter of 2015 upon the issuance of our senior notes. See Note 5.

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Note 2 — Net Income per Common Share

Total shares underlying stock options of 0.1 million were excluded from the computation of diluted net income per share for the quarter and nine months ended September 30, 2015 as they were anti-dilutive. Total shares underlying stock options of 0.2 million were excluded from the computation of diluted net income per share for the quarter and nine months ended September 30, 2014, 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 and nine months ended September 30, 2015 and 2014, 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 $4.7 million in the first nine months of 2015 to cover unfunded benefits and expect to contribute an additional $0.3 million in 2015. We contributed $25.7 million to our U.S. non-qualified defined benefit retirement plans during the 2014 fiscal year.

We contributed $1.3 million and $1.7 million to our European defined benefit retirement plans in the third quarters of 2015 and 2014, respectively.  Contributions to the defined benefit retirement plans were $4.0 million and $4.9 million for the nine months ended September 30, 2015 and 2014. We plan to contribute approximately $5.2 million during 2015 to these European plans. We contributed $6.1 million to our European plans during the 2014 fiscal year.

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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 and nine months ended September 30, 2015 and 2014 were immaterial.

In connection with our postretirement plans, we contributed $0.1 million and $0.2 million during the nine-month periods ended September 30, 2015 and 2014, respectively.  Contributions during the third quarters of 2015 and 2014 were each about $0.1 million. We periodically fund our postretirement plans to pay covered expenses as they are incurred. Based on nine months of activity, we expect to contribute approximately $0.2 million in 2015 to cover unfunded benefits. We contributed $0.2 million to our postretirement plans during the 2014 fiscal year.

Note 5 — Debt

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 third quarter was 4.76%. The fair value of the senior notes based on quoted prices utilizing level 2 inputs was $303 million at September 30, 2015.

In April 2015, the FASB issued ASU 2015-03, which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability. For public business entities, the standard is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption of the amendments in this update is permitted for financial statements that have not been previously issued. We adopted this standard during the third quarter of 2015 upon the issuance of our Senior Unsecured Notes due 2025. The balance for unamortized deferred financing costs and debt discount related to the senior notes was $3.6 million at September 30, 2015. The adoption of the ASU did not affect the classification of deferred financing cost related to our Facility.

At September 30, 2015, total borrowings under our $700 million Facility were $300 million, which approximates fair value. 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 September 30, 2015 we had issued letters of credit under the Facility totaling $2.1 million, resulting in undrawn availability under the Facility as of September 30, 2015 of $397.9 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 average interest rate on the Facility was 2.0% for the quarter and 1.84% for the first nine months of 2015. The average interest rate was 1.88% for 2014.

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Note 6 — Derivative Financial Instruments

Interest Rate Swap Agreements

As of September 30, 2015 the Company had two agreements to swap $75 million of floating rate obligations for fixed rate obligations at an average of 0.959% and 0.754% against LIBOR in U.S. dollars. Of the total of $150 million of swaps outstanding at September 30, 2015, $50 million matures each of March 2016, September 2016, and March 2017. All of the swaps were accounted for as cash flow hedges of our floating rate bank loans. To ensure the swaps were highly effective, all the principal terms of the swaps matched the terms of the bank loans. The fair value of the interest rate swaps was a liability of $0.5 million at September 30, 2015 and an asset of $0.1 million and a liability of $0.3 million at December 31, 2014.

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 March 2018, which we account for as cash flow hedges.  The aggregate notional amount of these contracts was $375.7 million and $255.8 million at September 30, 2015 and December 31, 2014, 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, losses of $0.3 million and losses of $16.3 million, were recorded in other comprehensive income (“OCI”) for the three months and nine months ended September 30, 2015, respectively, and losses of $10.8 million and $9.0 million for the three and nine-month periods ended September 30, 2014, respectively.  We classified the carrying amount of these contracts of $2.2 million in other assets and $17.8 million in other liabilities on the Condensed Consolidated Balance Sheets at September 30, 2015 and $0.3 million in other assets and $12.7 million classified in other liabilities at December 31, 2014.  During the three months ended September 30, 2015 and 2014, we recognized net losses of $4.2 million and net gains of $1.6 million, respectively, recorded in gross margin.  During the nine months ended September 30, 2015 and 2014, we recognized net losses of $13.0 million and net gains of $5.0 million, respectively, recorded in gross margin.  For the quarters ended September 30, 2015 and 2014, 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 September 30, 2015 and 2014, we recognized net foreign exchange gains of $1.5 million and net foreign exchange losses of $8.2 million, respectively, in the Condensed Consolidated Statements of Operations.  During the nine-month periods ended September 30, 2015 and 2014, we recognized net foreign exchange losses of $12.5 million and $7.9 million, respectively, in the Condensed Consolidated Statements of Operations in gross margin. 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 $1.8 million classified in other assets and less than $0.1 million in other liabilities and $0.8 million classified in other assets and $5.5 million in other liabilities on the September 30, 2015 and December 31, 2014 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 and nine months ended September 30, 2015 and 2014 was as follows:

We expect to reclassify $9.0 million of unrealized losses into earnings over the next twelve months as the hedged sales are recorded.

Commodity Hedging

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Beginning in 2015, we began a program to reduce the impact of the purchase price variability of a key raw material. The purpose of these contracts is to hedge a portion of the forecasted purchases thereby reducing our exposure to the impact of price variations.  The effective portion of these hedges was recorded in OCI for the three and nine-month periods ending September 30, 2015.  For the three and nine-month periods ended September 30, 2015, the impact of these hedges on our financial statements was immaterial. We classified the carrying amount of these contracts of $0.8 million in other liabilities on the Condensed Consolidated Balance Sheets at September 30, 2015.

Note 7 — Income Taxes

The income tax provisions for the quarter and nine months ended September 30, 2015 were $20.7 million and $60.6 million, respectively. The effective tax rate for the third quarter and nine-month period of 2015 was 28.2% and 25.0%, respectively. The 2015 third quarter included a $1.8 million benefit from favorable tax return to provision adjustments. The first quarter of 2015 included $11.6 million of benefits primarily related to the release of reserves for uncertain tax positions.  Excluding these discrete benefits, our effective tax rate for the nine months was 30.6%. The income tax provisions for the quarter and nine months ended September 30, 2014 were $21.2 million and $66.9 million, respectively.  The effective tax rate for the third quarter of 2014 was 27.7%. The 2014 third quarter included a $1.7 million benefit from favorable tax return to provision adjustments and the release of reserves for uncertain tax provisions. The effective tax rate for the nine-month 2014 period was 30.1%.

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 $4.0 million and $19.2 million, respectively at September 30, 2015. 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:

Counterparties to the above contracts are highly rated financial institutions, none of which experienced any significant downgrades in the three months ended September 30, 2015 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.

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Financial information for our operating segments for the quarters and nine months ended September 30, 2015 and 2014 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 — Other Operating Expense

The nine-month period ended September 30, 2014 included a pre-tax charge of $6.0 million for additional environmental reserves primarily related to a former manufacturing facility in Lodi, New Jersey (see note 12).

Note 11 — Other Non-Operating Expense

In September 2014, the Company entered into a new $700 million senior unsecured revolving credit facility that matures in 2019.  As a result of this refinancing, we accelerated certain unamortized costs of the credit facility being replaced incurring a pretax charge of $0.5 million in the third quarter of 2014.

Note 12 — 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.

Lodi, New Jersey Site

Pursuant to the New Jersey Industrial Site Recovery Act, Hexcel entered into an Administrative Consent Order for the environmental remediation of a manufacturing facility we own and formerly operated in Lodi, New Jersey.  Hexcel has completed all active investigation and remediation activities, including restoration of the river embankment and installation of a barrier to prevent contaminant migration. We remediated this site in accordance with a State approved plan and are now awaiting a Response Actions Outcome from the New Jersey Licensed Site Remediation Professional. Hexcel is in the process of monitoring contaminant levels to support a Monitored Natural Attenuation program. The accrual balance was about $0.1 million as of September 30, 2015 and was $1.7 million at December 31, 2014.

Lower Passaic River

Hexcel and a group of approximately 72 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.

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In June 2007, the EPA issued a draft Focused Feasibility Study (“FFS”) that considers interim remedial options for the lower eight miles of the river, in addition to a “no action” option. On April 11, 2014, the EPA issued a revised FFS, which proposes several alternatives, including the bank to bank dredging of the lower eight miles of the river at an expected cost ranging from $0.8 billion to $3.25 billion, according to the EPA, but also includes a “no action” option.  The comment period for the revised FFS closed on August 20, 2014 and we are awaiting a final decision.  Hexcel is not currently subject to any obligation to undertake the work contemplated by the FFS, nor have we determined our allocable share of any remediation alternatives. 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 recorded the lower end of the expected range. The accrual balance was $1.9 million as of September 30, 2015 and $2.1 million at December 31, 2014. Despite the issuance of the revised FFS, there are many uncertainties associated with the final agreed upon remediation and the Company’s allocable share of the remediation. 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.

Kent, Washington Site

We were party to a cost-sharing agreement regarding the operation of certain environmental remediation systems necessary to satisfy a post-closure care permit issued to a previous owner of our Kent, Washington site by the EPA.  Under the terms of the cost-sharing agreement, we were obligated to reimburse the previous owner for a portion of the cost of the required remediation activities.  The previous owner, who also continues to own an adjacent site, has installed certain remediation and isolation technologies on its upgradient site and is operating those pursuant to an order agreed with the State of Washington.  We and the Washington Department of Ecology have reached an agreed order to perform certain cleanup activities on our site by certain deadlines, and we are in full compliance with the order.  The Department of Ecology has recently approved a reduced number of wells and a reduced pumping volume for Hexcel’s wells on its property and agreed with a plan for more active remediation going forward. The total accrued liability related to this matter was $0.5 million at September 30, 2015 and December 31, 2014.

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 $0.4 million at September 30, 2015 and $0.6 million at December 31, 2014.

Summary of Environmental Reserves

Our estimate of liability as a PRP and our remaining costs associated with our responsibility to remediate the Lodi, New Jersey; Kent, Washington; and other sites are accrued in the consolidated balance sheets. As of September 30, 2015, our aggregate environmental related accruals were $3.0 million, of which $1.4 million was included in accrued liabilities with the remainder included in non-current liabilities.  As of December 31, 2014, our aggregate environmental related accruals were $5.0 million, of which $3.2 million was included in accrued liabilities with the remainder included in non-current liabilities. As related to certain environmental matters, except for the Lodi site, 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 $28 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 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 the quarters ended September 30, 2015 and 2014 was $0.5 million and $0.2 million, respectively, and $2.8 million and $2.9 million for the nine months ended September 30, 2015 and 2014.  In addition, our operating costs relating to environmental compliance charged to expense were $3.1 million and $3.4 million for the quarters ended September 30, 2015 and 2014, respectively, and $9.5 million and $10.7 million for the nine-month periods ended September 30, 2015 and 2014, respectively.  Capital expenditures for environmental matters were $1.8 million and $2.4 million for the quarters ended September 30, 2015 and 2014, respectively and $4.2 million and $4.6 million for the nine-month periods ended September 30, 2015 and 2014, respectively.

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Value Added Tax (VAT)

The Company identified numerous cross border European transactions for which it had not been properly charging VAT. We recorded a liability for the estimated amount of unpaid VAT at $22.0 million and also recorded a corresponding receivable for the VAT due from our customers. We have now either re-invoiced customers or were assigned the customers’ refund for the VAT. In addition, we recorded $1.3 million for interest payable on the unpaid VAT. We expect to settle the outstanding amounts for the VAT in the fourth quarter but cannot determine with certainty whether we will incur additional charges related to this matter.

Product Warranty

We provide for an estimated amount of product warranty expense at the time revenue is recognized. This estimated amount 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 September 30, 2015, and accrued warranty cost, included in “accrued liabilities” in the condensed consolidated balance sheets at September 30, 2015 and December 31, 2014, were as follows:

Note 13 — Stock Repurchase Plan

In October 2015, our Board authorized the repurchase of an additional $250 million of the Company’s stock (“2015 Repurchase Plan”).

In June 2014, our Board authorized a plan to repurchase $150 million of our outstanding common stock (“2014 Repurchase Plan”). At December 31, 2014, there was $100 million remaining authorized under the 2014 Repurchase Plan. During the third quarter of 2015 the Company spent $100 million to repurchase more than 2 million shares of common stock, which completed the 2014 Repurchase Plan.

In July 2013, our Board authorized us to repurchase $150 million of our outstanding common stock (“2013 Repurchase Plan”), which was completed during the second quarter of 2014.

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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 composites, including carbon fibers, specialty reinforcements, prepregs and other fiber-reinforced matrix materials, adhesives, honeycomb, engineered honeycomb and composite structures, for use in Commercial Aerospace, Space & Defense and Industrial Applications. 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 a variety of other industrial applications.

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

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 product lines.

Net sales for the quarter were $448.8 million, 0.7% lower (2.1% higher in constant currency) than the $451.9 million reported for the third quarter of 2014.  Year to date net sales of $1,396.3 million were 4.6% higher in constant currency than the 2014 period.  The growth was led by the commercial aerospace market, which accounts for 69% of our year to date sales.

Commercial aerospace sales of $314.5 million increased 6.1% for the quarter (7.4% in constant currency) as compared to the third quarter of 2014 and increased 5.7% (7.8% in constant currency) for the nine-month period as compared to 2014.   Combined revenues attributed to new aircraft programs (B787, A350 XWB, A320neo, and B737 MAX) increased more than 50% versus the third quarter last year with A350 XWB shipments leading the growth.  Sales for Airbus and Boeing legacy aircraft were about 8% lower compared to the third quarter of 2014, driven primarily by lower sales to the A380, A330 and the B747-8.  

Sales to other commercial aerospace, which includes regional and business aircraft customers, were down about 20% in constant currency compared to the third quarter of 2014.  For the first nine months of 2015 sales were about the same as the comparable period in 2014 on a constant currency basis.

Space & Defense sales of $77.3 million decreased 12.7% (9.9% in constant currency) for the quarter as compared to the third quarter of 2014.  The first nine months sales are down 8.0% (4.4% in constant currency).  Our top 10 programs account for about 60% of our Space & Defense sales and in aggregate are slightly higher for the quarter and the first nine months of 2015 than for the comparable 2014 periods. In total we are on more than 100 programs and the decline in sales has come from programs with historically less predictable ordering patterns. For the first nine months of 2015, the expected end of the C17 program accounts for about $10 million of the decline in the sales compared to 2014, and commercial helicopter sales (which comprise less than 10% of Space & Defense sales) were about 20% lower than the comparable 2014 period.

Total Industrial sales of $57.0 million for the third quarter of 2015 were 14.8% lower (6.3% in constant currency) than the third quarter of 2014. Sales for the first nine months of 2015 were down 8.5% (1.8% higher in constant currency) from the first nine months of 2014.  Wind energy sales for the nine months of 2015 were slightly higher in constant currency, and the rest of Industrial sales were also slightly higher as compared to the same period in 2014.

Gross margin for the third quarter was 27.7% compared to 27.0% in the third quarter of 2014, and for the first nine months of 2015 gross margin was 29.0% compared to 27.5% for the comparable 2014 period reflecting strong operating performance. The third quarter of 2015 was favorably impacted from exchange rates by about 50 basis points as compared to 2014, and the first nine months of 2015 were favorably impacted by about 70 basis points compared to 2014.

Selling, general and administrative expenses were 7.9% higher than the third quarter of 2014 and 8.4% higher for the first nine months of 2015 compared to the 2014 period, as we continue to add infrastructure to support our growth including implementing our new ERP and other systems. Our total year-to-date information technology expenses were about $8 million higher than the amount incurred year to date in 2014, including $3 million in the third quarter. We are in the final phase of installing a companywide ERP system and are accelerating our efforts to finish. The new systems will be an integral part of our continuous efforts to improve our efficiencies and to help us deliver the expected upcoming growth. Research and technology expenses in the third quarter of 2015 of

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$10.6 million were $0.5 million higher than the comparable 2014 period, and 3% lower (but 6% higher in constant currency) for the nine months compared to the 2014 period.

Free cash flow (defined as cash provided by operating activities less capital expenditures) for the first nine months of 2015 was a use of $85 million versus a use of $3 million in 2014. Working capital was a use of $117 million as compared to a $76 million use in 2014. The working capital increase is primarily timing of cash payments and a strategic build-up of inventories for selected programs and safety stock related to the ERP systems implementation. Cash used for capital expenditures was $249 million in the first nine months of 2015 compared to $194 million in the 2014 period. Accrual basis additions to capital expenditures were $228 million in the first nine months of 2015 as compared to $179 million during the first nine months of 2014. We expect accrual basis capital expenditures to be at the high end of the $260 million to $290 million range in 2015, as we continue to expand capacity to meet the planned needs of our customers.  The largest driver of our capital expenditures was capacity additions for the planned ramp-up of the A350.

Financial Overview

Results of Operations

The Company’s performance measurements include sales measured in constant dollars, operating and net income adjusted for special items and free cash flows, 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 and nine months ended September 30, 2015 and 2014: