HEXCEL CORP /DE/ - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended September 30, 2020

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

Securities registered pursuant to Section 12(b) of the Act:

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes  ☒    No  ☐

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

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

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

Indicate the number of shares outstanding of each of the issuer’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

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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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

Condensed Consolidated Statements of Stockholders’ Equity

For the Three and Nine Months ended September 30, 2020, and September 30, 2019

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, 2019 for a discussion of our significant accounting policies.

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared from the unaudited accounting records of Hexcel pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) and in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information.  Certain information and footnote disclosures normally included in financial statements have been omitted pursuant to rules and regulations of the SEC. In the opinion of management, the condensed consolidated financial statements include all normal recurring adjustments as well as any non-recurring adjustments necessary to present fairly the statement of financial position, results of operations, cash flows and statement of stockholder’s equity for the interim periods presented.  The condensed consolidated balance sheet as of December 31, 2019 was derived from the audited 2019 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 2019 Annual Report on Form 10-K.

Investments in Affiliated Companies

We have a 50% equity investment in Aerospace Composites Malaysia Sdn. Bhd. and a 25% equity investment in HexCut Services SAS.  These investments are accounted for using the equity method of accounting.      

Merger Termination

On January 12, 2020, we announced that we had entered into an agreement and plan of merger (the “Merger Agreement”) with Woodward, Inc. (“Woodward”), which provided for the combination of Hexcel and Woodward in an all stock merger of equals (the “Merger”).  In response to the impact of the novel strain of coronavirus (“COVID-19”) pandemic, on April 5, 2020, Hexcel and Woodward entered into an agreement to terminate the Merger Agreement.

Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2016-13, Financial Instruments – Credit Losses (Topic 326). The Accounting Standards Codification 326, Financial Instruments- Credit Losses (“ASC 326”) requires a financial asset measured at amortized cost basis to be presented at the net amount expected to be collected. We adopted the update, effective January 1, 2020, applying this standard to our Accounts Receivable and Contract Assets. Our high-quality credit review practice and good customer relationships has resulted in accounts receivable write offs below 0.5% of our annual sales. Due to the requirements of ASC 326, we have reviewed and refined our bad debt reserve process. Management reviews the average annual charge-off rate along with an assessment of current micro and macro-economic factors to determine any required reserves. If at any time management finds that there are significant changes to any of these contributing factors, the reserve will be adjusted accordingly. In the nine months ended September 30, 2020 we recorded $0.2 million of reserves and there were no write-offs against receivables resulting in a reserve balance of $0.8 million at September 30, 2020.

In August 2018, the FASB issued ASU No. 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20), which amends the current disclosure requirements regarding defined benefit pensions and other post retirement plans, and allows for the removal of certain disclosures, while adding certain new disclosure requirements. This standard is effective for fiscal years beginning after December 15, 2020 and allows for early adoption. We do not expect this new standard to have a significant impact to our disclosures.

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes which amends and aims to simplify accounting disclosure requirements regarding a number of topics including: intraperiod tax allocation, accounting for deferred taxes when there are changes in consolidation of certain investments, tax basis step up in an acquisition and the application of effective rate changes during interim periods, amongst other improvements. This standard is

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effective for fiscal years beginning after December 15, 2020 and allows for early adoption. We are assessing the impact of this new standard on our consolidated balance sheets, statements of operations and our future disclosures. 

Note 2 — Net Income Per Common Share

Total shares underlying stock options of 1.5 million and 0.9 million, were excluded from the computation of diluted net income per share for the three and nine months ended September 30, 2020, respectively, as they were anti-dilutive. Total shares underlying stock options of 0.1 million were excluded from the computation of diluted net income per share for both the three and nine months ended September 30, 2019, as they were anti-dilutive.

Rights Plan

On April 6, 2020, the Company declared a dividend of one preferred share purchase right (a “right”) for each outstanding share of the Company’s common stock and adopted a stockholder rights plan, as set forth in the rights agreement entered into as of April 6, 2020, between the Company and American Stock Transfer & Trust Company, LLC, as rights agent. The dividend was payable on April 16, 2020 to stockholders of record of the Company’s common stock on such date. In general, the rights plan works by imposing a significant penalty upon any person or group which acquires 15% or more of the outstanding common stock without the prior approval of the board. If the rights become exercisable, each right will allow its holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock for $150.00. This portion of a preferred share will give the stockholder approximately the same dividend, voting and liquidation rights as would one share of common stock. The rights will not be exercisable until ten days after the public announcement that a person or group has become an “acquiring person” (as defined in the rights agreement) by obtaining beneficial ownership of 15% or more of our outstanding common stock. Prior to exercise, the right does not give its holder any dividend, voting, or liquidation rights. The rights will expire on April 6, 2021. The rights were not exercisable at any time through September 30, 2020.

Note 3 — Inventories

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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 quarter and nine months ended September 30, 2020 and 2019 were as follows:

All costs related to our pensions are included as a component of operating income in our condensed consolidated statements of operations. For the quarters ended September 30, 2020 and 2019, amounts unrelated to service costs were a benefit of $0.5 million and $0.8 million, respectively. For the nine months ended September 30, 2020 and 2019, amounts unrelated to service costs were a benefit of $1.6 million and $2.5 million, respectively.

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Contributions

We generally fund our U.S. non-qualified defined benefit retirement plans when benefit payments are incurred.  We have contributed approximately $0.5 million in the first nine months of 2020 to cover unfunded benefits.  We expect to contribute a total of $1.4 million in 2020 to cover unfunded benefits.  We contributed $0.5 million to our U.S. non-qualified defined benefit retirement plans during the first nine months of 2019.

We contributed $3.0 million and $3.3 million to our European defined benefit retirement plans during the nine months ended September 30, 2020 and 2019, respectively.  We plan to contribute approximately $5.0 million during 2020 to our European plans.

Postretirement Health Care and Life Insurance Benefit Plans

We recorded $0.3 million and $0.2 million of net amortization gain deferral for the quarters ended September 30, 2020 and 2019, respectively; and $0.8 million and $0.7 million for the nine months ended September 30, 2020 and 2019, respectively. Net periodic benefit costs of our postretirement health care and life insurance benefit plans for the quarters and nine months ended September 30, 2020 and 2019 were immaterial.

Amounts contributed in connection with our postretirement plans were immaterial for both the nine months ended September 30, 2020 and 2019. We periodically fund our postretirement plans to pay covered expenses as they are incurred. We expect to contribute less than $0.5 million in 2020 to cover unfunded benefits.

Note 5 –– Debt

In June 2019, the Company refinanced its senior unsecured credit facility (the “Facility”), increasing borrowing capacity from $700 million to $1 billion. The Facility matures in June 2024. The interest rate ranges from LIBOR + 0.875% to a maximum of LIBOR + 1.50%, depending upon the better of the Company’s leverage ratio or the credit rating. During the second quarter of 2020, the interest rate for the Facility increased to LIBOR + 1.125%, reflecting a change in the leverage ratio. As of September 30, 2020, total borrowings under the Facility were $302 million, which approximates fair value. The Facility agreement permits us to issue letters of credit up to an aggregate amount of $50 million. Outstanding letters of credit reduce the amount available for borrowing under the Facility. As of September 30, 2020, there were no issued letters of credit under the Facility, resulting in undrawn availability under the Facility of $698 million, subject to ongoing covenant compliance. The weighted average interest rate for the Facility was 1.76% for the nine months ended September 30, 2020.

The Facility agreement contains financial and other covenants, including, but not limited to customary restrictions on the incurrence of debt by our subsidiaries and the granting of liens, as well as the maintenance of an interest coverage ratio and a leverage

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ratio. As defined in the Facility agreement, we are required to maintain a minimum interest coverage ratio of 3.50 (based on the ratio of EBITDA to interest expense) and may not exceed a maximum leverage ratio of 3.75 (based on the ratio of total debt to EBITDA) with a step up to 4.25 allowed following certain acquisitions. In addition, the Facility agreement contains other customary terms and conditions such as representations and warranties, additional covenants and events of default.

In September 2020, we amended our Facility (the “Amendment”) to allow for relief from certain terms of the Facility from October 1, 2020 through and including September 30, 2021 (the “Covenant Relief Period”).  During the Covenant Relief Period, we are required to maintain a leverage ratio not greater than: 4.25, 5.75, 5.00 and 4.25, respectively, for each of the quarterly test periods from December 31, 2020 through September 30, 2021. During the Covenant Relief Period, consolidated total debt is calculated net of unrestricted cash and cash equivalents in an amount not to exceed $200 million.  Additionally, during the Covenant Relief Period, we are subject to (i) limitations on share repurchases, (ii) further limitations on the incurrence of secured indebtedness, and (iii) an increase in pricing based on the then existing leverage ratio.  

In 2017, the Company issued $400 million in aggregate principal amount of 3.95% Senior Unsecured Notes due in 2027. The interest rate on these senior notes may be increased 0.25% each time a credit rating applicable to the notes is downgraded. Conversely, such increases would be reversed should the credit rating be subsequently upgraded. The maximum rate is 5.95%. The effective interest rate for nine months ended September 30, 2020 was 3.87% inclusive of approximately a 0.25% benefit of treasury locks. Based on quoted prices, the fair value of the senior unsecured notes due in 2027 was $431.1 million at September 30, 2020.

In January 2020, we used $49.9 million to repay and terminate the Euro term loan.    

In 2015, the Company issued $300 million in 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. Conversely, such increases would be reversed should the credit rating be subsequently upgraded. The maximum rate is 6.7%.  The effective interest rate for the nine months ended September 30, 2020 was 4.83%. Based on quoted prices, the fair value of these notes was $334.0 million at September 30, 2020.

Note 6 — Derivative Financial Instruments

Interest Rate Swap and Interest Lock Agreements

In January 2020, we terminated €45 million of interest rate swaps when we repaid the Euro term loan recognizing a charge of $0.7 million. These interest rate swaps fixed the interest rate at a weighted average of 0.5%. These swaps were designated as cash flow hedges to floating rate bank loans, therefore, the fair value of the agreements was recorded in other assets or as a liability with a corresponding amount to other comprehensive loss.

The Company had treasury lock agreements to protect against unfavorable movements in the benchmark treasury rate related to the issuance of our 3.95% Senior Unsecured Notes. These hedges were designated as cash flow hedges; therefore, any change in fair value was recorded as a component of other comprehensive loss. As part of the issuance of these notes, we net settled the derivatives and therefore the previously deferred gains recorded in other comprehensive loss will be released to interest expense over the life of the senior notes. The effect of these treasury locks reduced the effective interest rate on these notes by approximately 0.25%.  

Foreign Currency Forward Exchange Contracts

A number of our European subsidiaries are exposed to the impact of exchange rate volatility between the U.S. dollar and the subsidiaries’ functional currencies, being either the Euro or the British Pound sterling. We entered into contracts to exchange U.S. dollars for Euros and British Pound sterling through March 2023, which we account for as cash flow hedges. The aggregate notional amount of these contracts was $272.5 million and $426.9 million at September 30, 2020 and December 31, 2019, respectively.  The purpose of these contracts is to hedge a portion of the forecasted transactions of our European subsidiaries under long-term sales contracts with certain customers. These contracts are expected to provide us with a more balanced matching of future cash receipts and expenditures by currency, thereby reducing our exposure to fluctuations in currency exchange rates.  The effective portion of the hedges, gains of $14.4 million and losses of $0.1 million, were recorded in other comprehensive loss for the quarter and nine months ended September 30, 2020 and losses of $16.9 million and $25.7 million for the quarter and nine months ended September 30, 2019.  We classified $7.2 million of the carrying amount of these contracts as assets ($4.6 million of which was recorded in prepaid expenses and other current assets) and $6.5 million as liabilities ($0.7 million of which is recorded in non-current liabilities), on the condensed consolidated balance sheets at September 30, 2020, and $3.7 million of the carrying amount of these contracts was classified in assets ($1.3 million of which was recorded in prepaid expenses and other current assets) and $15.5 million as liabilities ($2.9 million of which is in other non-current liabilities) at December 31, 2019.  We recognized net losses of $2.6 million and $12.7 million in gross

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margin during the quarter and nine months ended September 30, 2020, and net losses of $3.8 million and $8.4 million for the quarter and nine months ended September 30, 2019.  

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 re-measurement 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, 2020 and 2019, we recognized net foreign exchange losses of $0.9 million and losses of $1.3 million, respectively, in the condensed consolidated statements of operations. During the nine months ended September 30, 2020 and 2019, we recognized net foreign exchange losses of $2.5 million and $1.9 million, respectively. The net foreign exchange impact recognized from these hedges offsets the translation exposure of these transactions. The carrying amount of the contracts for derivatives not designated as hedging instruments was $0.2 million classified as current assets at September 30, 2020, and $0.6 million as current assets and less than $0.1 million of current liabilities on our consolidated balance sheets at December 31, 2019, in the condensed consolidated balance sheets.

 The change in fair value of our foreign currency forward exchange contracts under hedge designations recorded net of tax within accumulated other comprehensive loss for the quarters and nine months ended September 30, 2020 and September 30, 2019 was as follows:

Unrealized losses of $1.2 million recorded in accumulated other comprehensive loss, plus a net tax benefit of $0.1 million, as of September 30, 2020, are expected to be reclassified into earnings over the next twelve months as the hedged sales are recorded.

Commodity Swap Agreements

On occasion we enter into commodity swap agreements to hedge against price fluctuations of raw materials, including propylene (the principal component of acrylonitrile).  As of September 30, 2020, we had commodity swap agreements with a notional value of $10.6 million. The swaps mature monthly through March 2022. The swaps are accounted for as a cash flow hedge of our forward raw material purchases. To ensure the swaps are highly effective, all of the critical terms of the swap matched the terms of the hedged items. The fair value of the commodity swap agreements was a liability of $3.2 million ($0.2 million of which was in other non-current liabilities) at September 30, 2020, and a liability of $5.4 million ($1.1 million of which was in other non-current liabilities) at December 31, 2019.

Note 7 — Income Taxes

The tax provision for the current quarter included a $46.2 million benefit primarily due to the release of a valuation allowance due to a legal entity rationalization and treasury realignment initiative. The tax provision for the first nine months of 2020 also included a $2.7 million benefit primarily for the release of reserves of unrecognized tax benefits as a result of tax audit settlements. The quarter and nine months ended September 30, 2019 included a $3.0 million benefit primarily due to tax credits identified in the quarter. Given the adverse impact of COVID-19 on our earnings, the effective tax rate in 2020 is not meaningful.

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:

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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 have no assets or liabilities that utilize Level 1 inputs. However, we have derivative instruments classified as liabilities and assets which utilize Level 2 inputs, and one liability that utilizes Level 3 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 $7.4 million and $9.7 million and $4.3 million and $21.7 million, respectively, at September 30, 2020 and December 31, 2019.  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 condensed consolidated balance sheets.

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 nine months ended September 30, 2020 that would reduce the receivable amount owed, if any, to the Company.

Liabilities classified as Level 3 — At September 30, 2020 we have a liability for $3.2 million, which represents contingent consideration that was recognized in connection with the Company’s Oxford Performance Materials, Inc. acquisition. This amount was estimated based on certain contractual stipulations which require payments to be made to the seller in the future based upon the achievement of certain results. We used forecasted results which were discounted using an internally derived discount rate. Future amounts payable may differ from this estimate by the difference between the actual and forecasted results. There were no payments and the amount of interest related to this liability accreted was not material during the nine months ended September 30, 2020.  

Note 9 — Revenue

Our revenue is primarily derived from the sale of inventory under long-term agreements with our customers. We have determined that individual purchase orders (“PO”), whose terms and conditions taken with a master agreement, create the ASC 606 contracts which are generally short-term in nature.  For those sales, which are not tied to a long-term agreement, we generate a PO that is subject to our standard terms and conditions. In instances where our customers acquire our goods related to government contracts, the contracts are typically subject to terms similar, or equal to, the Federal Acquisition Regulation Part 52.249-2.  This regulation contains a termination for convenience clause (“T for C”), which requires that the customer pay for the cost of both the finished and unfinished goods at the time of cancellation plus a reasonable profit.

We recognize revenue over time for those agreements that have T for C, and where the products being produced have no alternative use.  As our production cycle is typically six months or less, it is expected that goods related to the revenue recognized over time will be shipped and billed within the next twelve months. Less than half of our agreements contain provisions which would require revenue to be recognized over time.

We disaggregate our revenue based on market for analytical purposes. The following table details our revenue by market for the quarters and nine months ended September 30, 2020 and 2019:

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Revenue recognized over time gives rise to contract assets, which represent revenue recognized but unbilled.  Contract assets are included in our condensed consolidated balance sheets as a component of current assets. The activity related to contract assets for the nine months ended September 30, 2020 is as follows: