HEXCEL CORP /DE/ - Quarter Report: 2021 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended June 30, 2021

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 in 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 Six Months ended June 30, 2021, and June 30, 2020

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, 2020 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 stockholders’ equity for the interim periods presented.  The Condensed Consolidated Balance Sheet as of December 31, 2020 was derived from the audited 2020 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 2020 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.      

Assets Held for Sale

In early November 2020 we closed our wind energy prepeg production facility in Windsor, Colorado and as a result, certain plant assets to be sold have been recorded in “Assets held for sale” in the Condensed Consolidated Balance Sheets at both June 30, 2021 and December 31, 2020. The sale of these assets is expected to occur in the third quarter of 2021.

Recently Adopted Accounting Pronouncements 

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2018-14 (ASU 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. Adoption of this new standard did not 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 effective for fiscal years beginning after December 15, 2020. Adoption of this new standard did not have a material impact on the Company.

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Note 2 — Net Income (Loss) Per Common Share

Total common stock equivalents of 0.7 million and 1.6 million were excluded from the computation of diluted net income (loss) per share for the quarter ended June 30, 2021 and 2020, respectively, because to do so would have been anti-dilutive. Total common stock equivalents of 1.1 million and 0.8 million were excluded from the computation of diluted net income (loss) per share for the six months ended June 30, 2021 and 2020, respectively, because to do so would have been 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 quarter and six months ended June 30, 2021 and 2020 were as follows:

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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 June 30, 2021 and 2020, amounts unrelated to service costs were a charge of $0.1 million and a benefit of $0.6 million, respectively. For the six months ended June 30, 2021 and 2020, amounts unrelated to service costs were a charge of $0.3 million and a benefit of $1.1 million, respectively.

Contributions

We generally fund our U.S. non-qualified defined benefit retirement plans when benefit payments are incurred.  We contributed approximately $0.3 million in the first six months of 2021 to cover unfunded benefits.  We expect to contribute a total of $3.4 million in 2021 to cover unfunded benefits.  We contributed $0.3 million to our U.S. non-qualified defined benefit retirement plans during the first six months of 2020.

We contributed $2.2 million and $1.9 million to our European defined benefit retirement plans during the six months ended June 30, 2021 and 2020, respectively. We plan to contribute approximately $5.6 million during 2021 to our European plans.

Postretirement Health Care and Life Insurance Benefit Plans

We recorded $0.2 million of net amortization gain deferral for both the quarters ended June 30, 2021 and 2020, and $0.4 million for both the six months ended June 30, 2021 and 2020. Net periodic benefit costs of our postretirement health care and life insurance benefit plans for the quarters and six months ended June 30, 2021 and 2020 were immaterial.

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Amounts contributed in connection with our postretirement plans were immaterial for both the six months ended June 30, 2021 and 2020. We periodically fund our postretirement plans to pay covered expenses as they are incurred. We expect to contribute less than $0.4 million in 2021 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. 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 ratio. 

In September 2020, we amended the Facility to allow for relief from certain terms, including adjusting the maximum leverage ratio covenant for a defined period.  On January 28, 2021, we further amended the Facility agreement (the “Second Amendment”) to provide that, from January 28, 2021 through and including March 31, 2022, we will not be subject to a maximum leverage ratio covenant but will instead be required to maintain Liquidity (as defined in the Facility agreement) of at least $250 million. Additionally, during such period, the Company will be subject to limitations on share repurchases, cash dividends, and its ability to incur secured debt, in each case subject to certain exceptions; the applicable margin and commitment fees are increased; the incremental facility will not be available; and if the Company’s public debt rating is downgraded to (i) BB or lower by Standard & Poor’s and (ii) Ba2 or lower by Moody’s, we will be required to grant liens on certain of our assets, which liens will be released upon the Company’s public debt rating being upgraded to BB+ or higher by Standard & Poor’s or Ba1 or higher by Moody’s.  The Company’s public debt rating as of June 30, 2021 is BB+/Baa3. In addition, the Second Amendment provides that the Company will not be subject to an interest coverage ratio covenant until the test period ending December 31, 2021 and revolving commitments under the Facility were reduced to $750 million.  In connection with the Second Amendment, we accelerated a portion of the deferred financing costs and recognized $0.9 million in interest expense during the first quarter of 2021. As of June 30, 2021, we were in compliance with all debt covenants.   

As of June 30, 2021, total borrowings under the Facility were $207 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 June 30, 2021, there were no issued letters of credit under the Facility, resulting in undrawn availability under the Facility of $543 million. The weighted average interest rate for the Facility was 4.04% for the six months ended June 30, 2021.

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 six months ended June 30, 2021 was 4.06% 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 $428.0 million at June 30, 2021.

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 six months ended June 30, 2021 was 5.01%. Based on quoted prices, the fair value of the senior unsecured notes due in 2025 was $330.2 million at June 30, 2021.

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Note 6 — Derivative Financial Instruments

Interest Rate Swap and Interest Lock Agreements     

At June 30, 2021 and December 31, 2020, we had no interest rate swap agreements outstanding.

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 for hedge accounting purposes thus any change in fair value was recorded as a component of other comprehensive (loss) income. As part of the issuance of our 3.95% Senior Unsecured Notes, we net settled these derivatives for $10 million in cash. As a result of settling these derivatives the previously deferred gains recorded in other comprehensive (loss) income will be released to interest expense over the life of the 3.95% Senior Unsecured Notes. The effect of these treasury locks reduced the effective interest rate on these notes by approximately 0.25%.      

Cross Currency and Interest Rate Swap Agreements

In November 2020, we entered into a cross currency and interest rate swap, which is designated as a cash flow hedge of a €270 million, 5-year amortizing, intercompany loan between one of our European subsidiaries and the U.S. parent company. Changes in the spot exchange are recorded to the general ledger and offset the fair value re-measurement of the hedged item. The net difference in the interest rates coupons is recorded as a credit to interest expense. The derivative swaps €270 million bearing interest at a fixed rate of 0.30% for $319.9 million plus fixed rate interest of 1.115%.  The interest coupons settle semi-annually. The principal will amortize each year on November 15, as follows: for years 1 through 4, beginning November 15, 2021, €50 million versus $59.2 million, and a final settlement on November 15, 2025 of €70 million versus $82.9 million. The carrying value of the derivative at June 30, 2021 is a current asset of $1.7 million and a long-term liability of $3.2 million

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 2023. The aggregate notional amount of these contracts was $222.5 million and $250.3 million at June 30, 2021 and December 31, 2020, 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 $1.5 million and losses of $3.9 million. were recorded in other comprehensive (loss) income for the quarter and six months ended June 30, 2021, respectively, and gains of $2.8 and losses of $14.5 million were recorded for the quarter and six months ended June 30, 2020, respectively.  We classified $7.9 million of the carrying amount of these contracts as assets ($6.7 million of which was recorded in prepaid expenses and other current assets) and $1.6 million as liabilities ($0.6 million of which is recorded in non-current liabilities) on the Condensed Consolidated Balance Sheets at June 30, 2021. $16.0 million of the carrying amount of these contracts was classified in assets ($10.7 million of which was recorded in prepaid expenses and other current assets) and $2.5 million as liabilities (less than $0.1 million of which is in other non-current liabilities) at December 31, 2020.  We recognized net gains of $1.9 million and $3.3 million in gross margin during the quarter and six months ended June 30, 2021, respectively, and net losses of $5.7 million and $10.1 million for the quarter and six months ended June 30, 2020, respectively.  

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 quarter and six months ended June 30, 2021, we recognized net foreign exchange gains of $0.5 million and losses of $1.1 million, respectively, in the Condensed Consolidated Statements of Operations. During the quarter and six months ended June 30, 2020, we recognized net foreign exchange losses of $0.7 million and $1.7 million, respectively. The net foreign exchange impact recognized from these hedges offset the translation exposure of these transactions. The carrying amount of the contracts for derivatives not designated as hedging instruments was $0.1 million classified in current liabilities at June 30, 2021, and $0.1 million classified in current liabilities on our Condensed Consolidated Balance Sheet at December 31, 2020.

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 The change in fair value of our foreign currency forward exchange contracts under hedge designations recorded net of tax within accumulated other comprehensive (loss) income for the quarters and six months ended June 30, 2021 and June 30, 2020 was as follows:

   Unrealized gains of $5.8 million recorded in accumulated other comprehensive loss, less taxes of $1.3 million, as of June 30, 2021, 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 June 30, 2021, we had commodity swap agreements with a notional value of $7.3 million. The swaps mature monthly through December 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 an asset of $3.9 million ($3.7 million of which was recorded in prepaid expenses and other current assets) at June 30, 2021, and an asset of $2.2 million ($1.5 million of which was recorded in prepaid expenses and other current assets) and a liability of $1.1 million at December 31, 2020.    

Note 7 — Income Taxes

The effective tax rate for the quarter ended June 30, 2021 was 58.0% and included a discrete tax charge of $2.7 million related to the remeasurement of the net deferred tax liability in a foreign jurisdiction as a result of a change in tax rate. The effective tax rate for the six months ended June 30, 2021 was 25.7% and included a discrete tax benefit of $3.2 million resulting from the revaluation of deferred tax liabilities related to a favorable U.S. state tax law change in addition to the $2.7 million discrete tax charge previously mentioned. The tax benefit for the quarter ended June 30, 2020 was $3.6 million and included a $2.7 million benefit primarily related to the release of reserves of unrecognized tax benefits as a result of tax audit settlements The effective tax rate was 16.5% for the first six months of 2020, including the $2.7 million benefit.

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 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 $13.5 million and $4.9 million, respectively, at June 30, 2021 and $18.4 million and $14.8 million, respectively, at December 31, 2020.  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.

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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, 2021 that would reduce the receivable amount owed, if any, to the Company.

Liabilities classified as Level 3 — At June 30, 2021 we had a liability for $0.4 million, which represented 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. 

Note 9 — Revenue

Our revenue is primarily derived from the sale of inventory under long-term contracts with our customers. We have determined that individual purchase orders (“PO”), the terms and conditions of which are taken with a master agreement, create the ASC 606 contracts which are generally short-term in nature.  For those sales that 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. All other revenue is recognized at a point in time.

We disaggregate our revenue based on market for analytical purposes. The following table details our revenue by market for the quarters and six months ended June 30, 2021 and 2020:

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 six months ended June 30, 2021 was as follows:

Accounts receivable, net includes amounts billed to customers where the right to payment is unconditional.  

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Note 10 — 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, 2021 and 2020 were as follows: