HEXCEL CORP /DE/ - Quarter Report: 2016 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarter Ended  June 30, 2016

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)

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, 2015 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, 2015 was derived from the audited 2015 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 2015 Annual Report on Form 10-K filed with the SEC on February 4, 2016.

Investments in Affiliated Companies

We have a 50% equity ownership investment in an Asian joint venture Aerospace Composites Malaysia Sdn. Bhd. (“ACM”).  This investment is accounted for using the equity method of accounting. In the second quarter of 2016, the Company invested a total of $25.0 million in two new affiliates. The investments are each below a 20% ownership level. The Company accounts for these investments using the cost method.

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 March of 2016, the FASB issued Accounting Standards Update No. 2016-09 (ASU 2016-09) "Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" intended to simplify the accounting for employee share-based payments. Under this guidance all excess tax benefits (“windfalls”) and deficiencies (“shortfalls”) related to employee stock compensation are recognized within income tax expense. Under prior guidance windfalls were recognized to Additional paid-in capital (“APIC”) and shortfalls were only recognized to the extent they exceed the pool of windfall tax benefits.

The new standard is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any interim or annual period. The Company early adopted ASU 2016-09 effective for the quarter ended March 31, 2016.  As a result of the adoption a tax benefit of $1.2 million was recorded in the first six months reflecting the excess tax benefits. The adoption was on a prospective basis and therefore had no impact on prior years.  The company also recorded an adjustment to opening retained earnings of $0.4 million to recognize U.S. net operating loss carryforwards attributable to excess tax benefits on stock compensation that had not been previously recognized to APIC because they did not reduce income taxes payable.

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Note 2 — Net Income per Common Share

Total shares underlying stock options of 0.4 million and 0.6 million were excluded from the computation of diluted net income per share for the quarter and six months ended June 30, 2016,  respectively, as they were anti-dilutive. Total shares underlying stock options of 0.1 million and 0.2 million were excluded from the computation of diluted net income per share for the quarter and six months ended June 30, 2015, respectively, as they were anti-dilutive.  

Note 3 — Inventories

Note 4 — Retirement and Other Postretirement Benefit Plans

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

Defined Benefit Retirement Plans

Net Periodic Benefit Costs

Net periodic benefit costs of our defined benefit retirement plans for the quarters and six months ended June 30, 2016 and 2015 were as follows:

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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 $0.1 million in each of the first two quarters of 2016 to cover unfunded benefits and expect to contribute a total of $0.5 million in 2016. We contributed $4.9 million to our U.S. non-qualified defined benefit retirement plans during the 2015 fiscal year.

We contributed $2.4 million and $1.3 million to our European defined benefit retirement plans in the second quarters of 2016 and 2015, respectively. Contributions to the defined benefit retirement plans were $2.7 million for each of the six months ended June 30, 2016 and 2015. We plan to contribute approximately $4.8 million during 2016 to these European plans. We contributed $4.3 million to our European plans during the 2015 fiscal year.

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 six months ended June 30, 2016 and 2015 were immaterial.

In connection with our postretirement plans, we contributed about $0.1 million during each of the six-month periods ended June 30, 2016 and 2015. We periodically fund our postretirement plans to pay covered expenses as they are incurred. Based upon six months of activity, we expect to contribute approximately $0.3 million in 2016 to cover unfunded benefits. We contributed $0.2 million to our postretirement plans during the 2015 fiscal year.

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Note 5 –– Debt

   In June 2016, The Company amended and extended its $700 million senior unsecured credit facility (“the Facility”). The maturity of the Facility was extended from September 2019 to June 2021. The amendment provided for a modest reduction in interest costs, as well as less restrictive covenants. The initial interest rate for the revolver (until the third quarter 2016 is reported) is LIBOR + 1.25%. The interest rate ranges from LIBOR + 0.875% to a maximum of LIBOR + 1.875%, depending upon the Company’s leverage ratio. At June 30, 2016 total borrowings under the Facility were $410 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 June 30, 2016 we had issued letters of credit under the Facility totaling $2.1 million, resulting in undrawn availability under the Facility as of June 30, 2016 of $287.9 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 1.9% for the first half of 2016. The average interest rate was 1.8% for 2015.

In June 2016 we also entered into a €60 million term loan.  The loan has two tranches of which the first tranche for €25 million has a three month availability period at a rate of Euribor +1.2% and a final maturity date of June 30, 2023. The second tranche for €35 million has a one year availability period at a rate of Euribor +1.25% and a final maturity date of June 30, 2024. There is a zero percent floor on the Euribor. The loans are payable in annual installments, beginning on June 30, 2017 and June 30, 2019, respectively. There were no amounts outstanding under this loan at June 30, 2016.

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 six-month period of 2016 was 4.8%. The fair value of the senior notes based on quoted prices utilizing level 2 inputs was $309.3 million at June 30, 2016.

Note 6 — Derivative Financial Instruments

Interest Rate Swap Agreements

As of June 30, 2016 the Company had two agreements to swap $50 million each of floating rate obligations for fixed rate obligations at an average of 1.03% and 0.89% against LIBOR in U.S. dollars. Of the total of $100 million of swaps outstanding at June 30, 2016, $50 million matures on each of 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 of the principal terms of the swaps matched the terms of the bank loans. The fair value of interest rate swaps was a liability of $0.1 million at June 30, 2016 and December 31, 2015.

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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 December 2018, which we account for as cash flow hedges.  The aggregate notional amount of these contracts was $415.8 million and $417.5 million at June 30, 2016 and December 31, 2015, 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 $15.1 million and $9.3 million, respectively, were recorded in other comprehensive income (“OCI”) for the three and six months ended June 30, 2016, and gains of $7.6 million and losses of $16.0 million for the three and six months ended June 30, 2015.  We classified the carrying amount of these contracts of $1.2 million in other assets and $23.0 million in other liabilities on the Condensed Consolidated Balance Sheets at June 30, 2016 and $0.9 million in other assets and $22.1 million classified in other liabilities at December 31, 2015.  During the three and six months ended June 30, 2016, we recognized net losses of $3.4 million and $8.5 million in gross margin, respectively. During the three and six months ended June 30, 2015, we recognized net losses of $5.2 million and $8.8 million in gross margin, respectively. For the quarters ended June 30, 2016 and 2015, 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 June 30, 2016 and 2015, we recognized net foreign exchange losses of $1.6 million and net foreign exchange gains of $2.5 million, respectively, in the Condensed Consolidated Statements of Operations. During the six months ended June 30, 2016 and 2015, we recognized net foreign exchange gains of $2.7 million and $2.5 million, respectively, in the Condensed Consolidated Statements of Operations. The net foreign exchange impact recognized from these hedges offset the translation exposure of these transactions. The carrying amount of the contracts for asset and liability derivatives not designated as hedging instruments was $0.1 million classified in other assets and $1.4 million in other liabilities and $0.4 million classified in other assets and $0.4 million in other liabilities on the June 30, 2016 and December 31, 2015 Condensed Consolidated Balance Sheets, respectively.

The change in fair value of our foreign currency forward exchange contracts under hedge designations recorded net of tax within accumulated other comprehensive income for the quarters ended June 30, 2016 and 2015 was as follows:

We expect to reclassify $10.6 million of unrealized losses into earnings over the next twelve months as the hedged sales are recorded.

Note 7 — Income Taxes

     The income tax provision for the quarter ended June 30, 2016 was $28.7 million. The effective tax rate for the second of quarter of 2016 was 30.5% as compared to a 30.6% effective tax rate for the second quarter of 2015.

     The income tax provision for the six-month period ended June 30, 2016 was $51.4 million, an effective tax rate of 29.8%. Effective for the quarter ended March 31, 2016, the Company early adopted Accounting Standards Update No. 2016-09 (ASU 2016-09) "Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting". Under this guidance all excess tax benefits (“windfalls”) and deficiencies (“shortfalls”) related to employee stock compensation are recognized within income tax expense. Under prior guidance windfalls were recognized to APIC and shortfalls were only recognized to the extent they exceed the pool of windfall tax benefits. 

     As a result of the adoption a tax benefit of $1.2 million was recorded in the first six months of 2016 reflecting the excess tax benefits. The adoption was on a prospective basis and therefore had no impact on prior years.  The company also recorded an adjustment to opening retained earnings of $0.4 million to recognize U.S. net operating loss carryforwards attributable to excess tax benefits on stock compensation that had not been previously recognized to APIC because they did not reduce income taxes payable,

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see Note 1. Excluding this discrete benefit, our effective tax rate was 30.5% for the six-month period of 2016.

     The 2015 six-month period income tax provision of $39.9 million 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 six months was 30.6%.

Note 8 — Fair Value Measurements

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

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

We do not have any significant assets or liabilities that utilize Level 3 inputs. In addition, we have no assets or liabilities that utilize Level 1 inputs. For derivative assets and liabilities that utilize Level 2 inputs, we prepare estimates of future cash flows of our derivatives, which are discounted to a net present value. The estimated cash flows and the discount factors used in the valuation model are based on observable inputs, and incorporate non-performance risk (the credit standing of the counterparty when the derivative is in a net asset position, and the credit standing of Hexcel when the derivative is in a net liability position). The fair value of these assets and liabilities was approximately $1.3 million and $24.6 million, respectively at June 30, 2016. 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 six months ended June 30, 2016 that would reduce the receivable amount owed, if any, to the Company.

Note 9 — Segment Information

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

Financial information for our operating segments for the quarters and six months ended June 30, 2016 and 2015 is as follows:

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We do not allocate Corporate expenses to the operating segments

Goodwill and Intangible Assets

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

Goodwill and intangible assets increased by $15.9 million in 2016 primarily due to the Formax acquisition, partially offset by foreign exchange rates. No impairments have been recorded against these amounts.

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Note 10 — Business Acquisition and Investments in Affiliates

In the second quarter of 2016, we acquired a 10.3% interest in Oxford Performance Materials (“OPM”) for $15.0 million. OPM produces thermoplastic, carbon fiber reinforced 3D printed parts primarily for Commercial Aerospace and Space and Defense applications. In addition, if OPM achieves certain milestones within an 18 month period or at Hexcel’s discretion, the Company will invest an additional $10 million, increasing its investment in OPM to 16.1%. We account for this investment using the cost method. We also issued an 8% convertible secured promissory note to Luminati Aerospace LLC (“Luminati”), in the amount of $10 million. Luminati is an aerospace technology company focusing on research, development, testing, and manufacturing of next generation solar-electric unmanned aerial vehicles, or UAVs.  The note matures in 2023 and the principal and interest are convertible to a 17.2% interest in Luminati. The note will convert upon Luminati achieving certain milestones or at Hexcel’s discretion.

On January 5, 2016 the Company acquired the remaining 50% of Formax (UK) Limited (“Formax”) for $12 million of which $8.6 million was paid on closing and the remaining will be paid in installments over the next four years. The Company previously acquired a 50% interest in the privately-owned company in December 2014.

Located in Leicester, U.K., Formax is a leading manufacturer of composite reinforcements, specializing in the production of lightweight carbon multi-axials and highly engineered glass fiber and aramid fiber fabrics. The total purchase price, net of cash acquired and including the 50% interest acquired in December 2014, was $22 million and the assumption of long-term debt of $8.2 million.

The step acquisition was accounted for under the acquisition method of accounting with the Company treated as the acquiring entity.  Accordingly, the consideration paid by the Company to complete the acquisition has been recorded to the assets acquired and liabilities assumed based upon their estimated fair values as of the date of acquisition. The Company engaged a third party to assist with the valuation of assets including property plant and equipment and intangible assets. The fair value of the property, plant and equipment was based upon the assessed value of the land, which was determined to approximate fair value, as well as the income approach in determining the fair value of building improvements and equipment.  The carrying values for current assets and liabilities were deemed to approximate their fair values due to the short-term nature of these assets and liabilities.  The excess of the purchase price over the estimated fair value of the net assets acquired, including identifiable intangible assets, of $10.2 million was allocated to goodwill. The goodwill recognized is attributable to expected revenue synergies generated by the integration of our products and technologies with those of Formax, costs synergies resulting from the consolidation or elimination of certain functions, and intangible assets that do not qualify for separate recognition, such as the assembled workforce of Formax.

Note 11 — Commitments and Contingencies

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

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

Environmental Matters

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

We have been named as a potentially responsible party (“PRP”) with respect to several hazardous waste disposal sites that we do not own or possess, which are included on, or proposed to be included on, the Superfund National Priority List of the U.S. Environmental Protection Agency (“EPA”) or on equivalent lists of various state governments. Because CERCLA allows for joint and

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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 and therefore we believe the spending is largely complete.    

Lower Passaic River Study Area

As of April 2016, Hexcel and a group of approximately 52 other PRPs comprise the Lower Passaic Cooperating Parties Group (the “CPG”). Hexcel and the CPG are subject to a May 2007 Administrative Order on Consent (“AOC”) to perform a Remedial Investigation/Feasibility Study (“RI/FS”) of environmental conditions in the Lower Passaic River watershed. We were included in the CPG based on our operations at our former manufacturing site in Lodi, New Jersey.

In March 2016, the EPA issued a Record of Decision (“ROD”) setting forth the EPA’s selected remedy for the lower eight miles of the river. The ROD calls for capping and dredging of the lower eight miles of the river, with the placement of an engineered cap over the entire eight miles, at an expected cost ranging from $0.97 billion to $2.07 billion, according to the EPA. Now that it has issued the final ROD, the EPA will seek to hold some combination of the PRPs liable to perform the work selected through the ROD. At this point, we have not yet determined our allocable share of performing the selected remedy. However, based on a review of the Company’s position, and as no point within the range is a more probable outcome than any other point, the Company has determined that its accrual is sufficient at this time. The accrual balance was $2.2 million and $1.9 million as of June 30, 2016 and December 31, 2015, respectively. Despite the issuance of the final ROD, there continue to be many uncertainties associated with the selected remedy 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 $0.4 million and $0.5 million at June 30, 2016 and December 31, 2015, respectively.

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 $0.7 million and $0.3 million at June 30, 2016 and at December 31, 2015, respectively.

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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; Lower Passaic River; Kent, Washington; and other sites are accrued in the consolidated balance sheets. As of June 30, 2016, our aggregate environmental related accruals were $3.5 million, of which $1.8 million was included in accrued liabilities with the remainder included in non-current liabilities.  As of December 31, 2015, our aggregate environmental related accruals were $2.9 million, of which $1.1 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 $16 million higher. These accruals can change significantly from period to period due to such factors as additional information on the nature or extent of contamination, the methods of remediation required, changes in the apportionment of costs among responsible parties, amount of insurance coverage, and other actions by governmental agencies or private parties, or the impact, if any, of being named in a new matter.

Environmental remediation spending charged to our reserve balance for the quarters ended June 30, 2016 and 2015 was $0.4 million and $1.0 million, respectively, and $0.5 million and $2.3 million for the six months ended June 30, 2016 and 2015. In addition, our operating costs relating to environmental compliance charged to expense were $2.6 million and $3.3 million for the quarters ended June 30, 2016 and 2015, respectively, and $4.9 million and $6.4 million for the six-month periods ended June 30, 2016 and 2015, respectively. Capital expenditures for environmental matters were $2.9 million and $1.8 million for the quarters ended June 30, 2016 and 2015, respectively, and $4.8 million and $2.4 million for the six-month periods ended June 30, 2016 and 2015, respectively.

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 June 30, 2016, and accrued warranty cost, included in “accrued liabilities” in the condensed consolidated balance sheets at June 30, 2016 and December 31, 2015, were as follows:

Note 12 — Stock Repurchase Plan

In October 2015, our Board authorized the repurchase of $250 million of the Company’s stock (“2015 Repurchase Plan”). During the first half of 2016 the Company spent $54.9 million to repurchase our common stock under the 2015 Repurchase Plan. As of June 30, 2016, the Company has $149 million remaining under the 2015 Repurchase Plan.

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

Business Overview

We develop, manufacture, and market lightweight, high-performance structural materials, including carbon fibers, specialty reinforcements, prepregs and other fiber-reinforced matrix materials, honeycomb, adhesives, engineered honeycomb and composite structures, for use in Commercial Aerospace, Space & Defense and Industrial markets. Our products are used in a wide variety of end applications, such as commercial and military aircraft, space launch vehicles and satellites, wind turbine blades, automotive, recreational products and 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 50% partner in a joint venture in Malaysia, which manufactures composite structures for Commercial Aerospace applications. In the second quarter of 2016, the Company invested a total of $25 million in two new affiliates. The investments are each below a 20% ownership level.

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 $522.6 million, 9.9% higher (10.2% higher in constant currency) than the $475.7 million reported for the second quarter of 2015.  Year to date net sales were 7.7% higher in constant currency. The growth was led by the commercial aerospace market, which accounts for 70% of our year to date sales.

Commercial aerospace sales of $368.4 million increased 13.5% for the quarter (14.3% in constant currency) as compared to the second quarter of 2015 and increased 11.4% (11.3% in constant currency) for the six-month period as compared to 2015. Combined revenues attributed to new aircraft programs (B787, A350 XWB, A320neo, and B737 MAX) increased more than 50% versus the second quarter and first six months of last year with A350 XWB shipments leading the growth.  Sales for Airbus and Boeing legacy aircraft were down slightly compared to the second quarter of 2015, but higher than the second half 2015 run rate.  

Sales to other commercial aerospace, which includes regional and business aircraft customers, were down about 15% compared to the strong second quarter of 2015, but sales for the first half of 2016 were about 10% above the second half 2015.

Space & Defense sales of $81.8 million decreased 7.0% (7.6% in constant currency) for the quarter as compared to the second quarter of 2015. Rotorcraft accounts for just over half of Space & Defense sales and, while they accounted for the majority of the decrease over last year, sales for both military and commercial rotorcraft were higher than each of the preceding three quarters. The first half sales are down 8.9% (9.1% in constant currency) compared to the prior year.  

Total Industrial sales of $72.3 million for the second quarter of 2016 were 14.8% higher (14.4% in constant currency) than the second quarter of 2015. Wind energy sales (which account for more than half of the total Industrial sales) were up mid-single digits compared to last year, with the rest of the growth in Industrial sales coming from the Formax acquisition.  Sales for the first half of 2016 were up 11.8% (12.5% in constant currency) over the second half of 2015.

Gross margin for the second quarter was 28.8% compared to 29.2% in the second quarter of 2015 as both periods reflected strong operating performance. Exchange rates did not impact the gross margin percentage for the second quarter of 2016 as compared to 2015.

Selling, general and administrative expenses were modestly higher than the second quarter of 2015. Research and technology expenses in the second quarter of 2016 of $11.6 million were $1.2 million higher than the comparable 2015 period and expenses for the first half of 2016 are just higher than the comparable period in 2015.

Free cash flow (defined as cash provided by operating activities less capital expenditures) for the first half of 2016 was a use of $21 million versus a use of $116 million in 2015. Cash provided by operating activities was $135 million compared to $50 million in 2015, as working capital used $72 million as compared to $135 million use in the first half of 2015. Our working capital has seasonal fluctuations and is expected to be a modest source of cash in the second half of 2016..  Cash used for capital expenditures was $156 million in the first half of 2016 compared to $166 million in the 2015 period. Accrual basis additions to capital expenditures were $142 million in both 2016 and 2015. We expect accrual basis capital expenditures to be in the $280 million to $320 million range in 2016, as we continue to expand capacity to meet the planned needs of our customers.  

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Financial Overview

Results of Operations

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

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Net Sales

The following table summarizes net sales to third-party customers by segment and end market for the quarters ended June 30, 2016 and 2015:

Sales by Segment

Composite Materials: Net sales of $425.3 million in the second quarter of 2016 increased $51.8 million over the $373.5 million in the prior year driven by an 18.0% increase in Commercial Aerospace sales partially offset by a decline in Space & Defense sales. Space & Defense sales declined 3.6% compared to the second quarter of 2015 primarily due to lower rotorcraft sales.  Industrial sales increased 14.8% as wind had mid-single digit sales increase and the rest from the Formax acquisition. The increase of 10.8% in net sales to $821.1 million for the first half of 2016 was also driven by Commercial Aerospace and Industrial, partially offset by a modest decline in Space and Defense sales.

Engineered Products: Net sales of $97.3 million in the second quarter of 2016 decreased $4.9 million from the $102.2 million for 2015 as driven by a decline in Space & Defense sales, particularly rotorcraft sales. The decrease of 3.6% in net sales to $199.2 million for the first half of 2016 was driven by a decline in Space & Defense sales as rotorcraft sales were lower. There were no significant sales to the Industrial market from this segment.

Sales by Market

Commercial Aerospace: Net sales increased $43.8 million, or 13.5% (14.3% in constant currency), to $368.5 million for the second quarter of 2016. Net sales for the six months ended June 30, 2016 increased $73.8 million or 11.4% (11.3% on a constant currency basis) to $718.8 million. Revenues attributed to new aircraft programs (B787, A350 XWB, A320neo, and B737 MAX) increased more than 50% versus the second quarter and first six months of last year with the A350 XWB shipments leading the growth.  Sales for Airbus and Boeing legacy aircraft were down modestly compared to the second quarter of 2015, but above the second half 2015 run rate.  

Sales to other commercial aerospace, which includes regional and business aircraft customers, were down about 15% compared to the strong second quarter of 2015, but sales for the first half of 2016 were about 10% above the second half 2015.  For the first half of 2016 sales were 15% lower than the comparable period in 2015.

Space & Defense: Net sales of $81.8 million decreased 7.0% (7.6% in constant currency) for the quarter as compared to the second quarter of 2015. The first half sales are down 8.9% (9.1% in constant currency). Rotorcraft accounts for just over half of Space & Defense sales and accounted for all of the decrease from last year, as sales were at the same run rate as the second half of 2015.

Industrial: Net sales of $72.3 million for the second quarter of 2016 were 14.8% higher (14.4% in constant currency) than the second quarter of 2015. Sales for the first half of 2015 were 11.8% higher (12.5% in constant currency) over the first half of 2015.   Wind energy sales (which account for more than half of the total Industrial sales) were up mid-single digits compared to last year, with the rest of the growth in Industrial sales coming from the Formax acquisition.  

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Gross Margin