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Article by DailyStocks_admin    (03-07-08 04:54 AM)

Filed with the SEC from Feb 21 to Feb 27:

Hexcel (HXL)
OSS Capital Management will nominate three candidates for election to the board at the 2008 annual meeting after composite material company indicated it would consider only one of its nominees. OSS Capital said it had no alternative but to proceed with a proxy contest to elect all three of its nominees. OSS Capital, which has been pushing Hexcel to explore strategic alternatives, said the appointment of only one of its nominees wouldn't provide sufficient change in the board. OSS Capital currently has 5,285,900 shares (5%).

BUSINESS OVERVIEW

General Development of Business



Hexcel Corporation, founded in 1946, was incorporated in California in 1948, and reincorporated in Delaware in 1983. Hexcel Corporation and its subsidiaries (herein referred to as “Hexcel”, “we”, “us”, or “our”), is a leading advanced composites company. We develop, manufacture, and market lightweight, high-performance composites, including carbon fibers, reinforcements, prepregs, honeycomb, matrix systems, adhesives and composite structures, for use in the commercial aerospace, space and defense and industrial applications. Our products are used in a wide variety of end applications, such as commercial and military aircraft, space launch vehicles and satellites, wind turbine blades, automotive, bikes, skis and a wide variety of other recreational equipment.



We serve international markets through manufacturing facilities and sales offices located in the United States and Europe, and through sales representation offices located in Asia, Australia and South America. We are also an investor in two joint ventures, one located in China and one in Malaysia, which manufacture composite structures for commercial aerospace.



Narrative Description of Business and Segments



We are a manufacturer of products within a single industry: Advanced Composites. In 2007, Hexcel successfully concluded the sale of a significant portion of our previously reported Reinforcements segment. In order to take full advantage of the many growing applications for advanced composite materials, we decided to narrow our focus and consolidate our activities around our carbon fiber, reinforcements for composites, honeycomb, matrix and engineered products product lines. In 2007, we completed the combination of our Reinforcements’ activities related to advanced composites with our previously reported Composites and Structures segments as a single organization. We successfully concluded the reorganization during 2007, with the divesture of our European Architectural business and the U.S. electronics, ballistics and general industrial (“EBGI”) product lines. These businesses are therefore being reported as discontinued operations within this annual report on Form 10-K. Unless otherwise indicated, all information within this annual report on Form 10-K reflects the continuing operations of Hexcel.



Hexcel now reports two segments, Composite Materials and Engineered Products, from the three segments reported in 2006, Composites, Structures and Reinforcements. The Composite Materials segment is now comprised of the same product lines as previously included under prior Composites segment, with the exception of specially machined honeycomb, which are now included under the Engineered Products segment, and the addition of the product lines previously reported under the Reinforcements segment that were not included in the sale of EBGI. The Engineered Products segment is comprised of the product lines previously included under the prior Structures segment, with the addition of the specially machined honeycomb product line. All prior financial statement periods have been revised to reflect the new segment structure.



The following summaries describe the ongoing activities related to the Composite Materials and Engineered Products segments as of December 31, 2007.



Composite Materials



The Composite Materials segment manufactures and markets carbon fibers, fabrics and specialty reinforcements, prepregs, structural adhesives, honeycomb, composite panels, molding compounds, polyurethane systems, gel coats and laminates that are incorporated into many applications, including military and commercial aircraft, wind turbine blades and recreational products.

Carbon Fibers: HexTow TM carbon fibers are manufactured for sale to third-party customers as well as for our own use in manufacturing certain reinforcements and composite materials. Carbon fibers are woven into carbon fabrics, used as reinforcement in conjunction with a resin matrix to produce pre-impregnated composite materials (referred to as “prepregs”) and used in filament winding and advanced fiber placement to produce finished composite components. Key product applications include structural components for commercial and military aircraft, space launch vehicles, wind blade components, and certain other applications such as recreational and industrial equipment.



Industrial Fabrics and Specialty Reinforcements : Industrial fabrics and specialty reinforcements are made from a variety of fibers, including carbon, aramid and other high strength polymers, several types of fiberglass, quartz, ceramic and other specialty fibers. These reinforcements are used in the production of prepregs and other matrix materials used in primary and secondary structural aerospace applications such as wing components, horizontal and vertical stabilizer components, fairings, radomes and engine nacelles as well as overhead storage bins and other interior components. Our reinforcements are also used in the manufacture of a variety of industrial and recreational products such as wind energy blades, automotive components, boats, surfboards, skis and other sporting goods equipment and certain civil engineering and construction applications.



Prepregs : HexPly ® prepregs are manufactured for sale to third-party customers and for internal use by our Engineered Products segment in manufacturing composite laminates and monolithic structures, including finished components for aircraft structures and interiors. Prepregs are manufactured by combining high-performance reinforcement fabrics or unidirectional fibers with a resin matrix to form a composite material with exceptional structural properties not present in either of the constituent materials. Reinforcement fabrics used in the manufacture of prepregs include glass, carbon, aramid, quartz, ceramic and other specialty reinforcements. Resin matrices include bismaleimide, cyanate ester, epoxy, phenolic, polyester, polyimide and other specialty resins.



Other Fiber-Reinforced Matrix Materials : New fiber reinforced matrix developments include HexMC ® , a new form of quasi-isotropic carbon fiber prepreg that enables small to medium sized composite components to be mass produced. HexTOOL is a specialized form of HexMC for use in the cost-effective construction of high temperature composite tooling. HexFIT ® film infusion material is a product that combines resin films and dry fiber reinforcements to save lay-up time in production and enables the manufacture of large contoured composite structures, such as wind turbine blades.



Resins : Polymer matrix materials are sold in bulk and film form for use in direct process manufacturing of composite parts. Resins can be combined with fiber reinforcements in manufacturing processes such resin transfer molding (RTM), resin film infusion (RFI) or vacuum assisted resin transfer molding (VARTM) to produce high quality composite components for both aerospace and industrial applications.



Structural Adhesives: We manufacture and market a comprehensive range of Redux â film and paste adhesives. These structural adhesives, which bond metal to metal and composites and honeycomb structures, are used in the aerospace industry and for many industrial applications.



Honeycomb : HexWeb ® honeycomb is a lightweight, cellular structure generally composed of nested hexagonal cells. The product is similar in appearance to a cross-sectional slice of a beehive. It can also be manufactured in asymmetric cell configurations for more specialized applications. Honeycomb is primarily used as a lightweight core material and acts as a highly efficient energy absorber. When sandwiched between composite or metallic facing skins, honeycomb significantly increases the stiffness of the structure, while adding very little weight.



We produce honeycomb from a number of metallic and non-metallic materials. Most metallic honeycomb is made from aluminum and is available in a selection of alloys, cell sizes and dimensions. Non-metallic materials used in the manufacture of honeycomb include fiberglass, carbon fiber, thermoplastics, non-flammable aramid papers, aramid fiber and other specialty materials.



We sell honeycomb as standard blocks and in slices cut from a block. Honeycomb is also supplied as sandwich panels, with facing skins bonded to either side of the core material. Aerospace is the largest market for honeycomb products. We also sell honeycomb for non-aerospace applications including automotive parts, high-speed trains and mass transit vehicles, energy absorption products, marine vessel compartments, portable shelters, and other industrial uses. In addition, we produce honeycomb for our Engineered Products segment for use in manufacturing finished parts for airframe Original Equipment Manufacturers (“OEMs”).

Net sales for the Composite Materials segment to third-party customers were $941.9 million in 2007, $858.2 million in 2006, and $791.5 million in 2005, which represented approximately 80%, 82%, and 83% of our net sales, respectively. Net sales for composite materials are highly dependent upon the number of large commercial aircraft produced as further discussed under the captions “Significant Customers,” “Markets” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In addition, about 3% of our total production of composite materials in 2007 was used internally by the Engineered Products segment.



Engineered Products



The Engineered Products segment manufactures and markets composite structures and precision machined honeycomb parts for use in the aerospace industry. Composite structures are manufactured from a variety of composite and other materials, including prepregs, honeycomb, structural adhesives and advanced molding materials, using such manufacturing processes as autoclave processing, multi-axis numerically controlled machining, heat forming, compression molding and other composite manufacturing techniques. Composite structures and machined honeycomb include such items as aerodynamic fairings, wing panels, rotor blades, and other specific aircraft components.

Net sales for the Engineered Products segment to third-party customers were $229.2 million in 2007, $191.3 million in 2006, and $166.1 million in 2005, which represented approximately 20%, 18%, and 17% of our net sales, respectively.



The Engineered Products business unit has equity investments in two Asian joint ventures. They consist of BHA Aero Composite Parts Co., Ltd. (“BHA Aero”) and Asian Composites Manufacturing Sdn. Bhd. (“ACM”). Under the terms of the joint venture agreements, Hexcel and Boeing have transferred the manufacture of certain semi-finished composite components to these joint ventures. Hexcel purchases the semi-finished composite components from the joint ventures, inspects and performs additional skilled assembly work before delivering them to Boeing. The joint ventures also manufacture composite components for other tier 1 aircraft component manufacturers. These Asian joint ventures had combined revenues of $63.0 million and $53.0 million in 2007 and 2006, respectively. For additional information on the Joint Venture investment see Note 6, Investments in Affiliated Companies .

Divestitures and Related Matters



In July of 2006, we announced our intention to explore strategic alternatives for portions of our previously reported Reinforcements segment. In order to take full advantage of the many growing applications for advanced composite materials, we decided to narrow our focus and consolidate our activities around our carbon fiber, reinforcements for composites, honeycomb, matrix and engineered products product lines. In doing so, we decided to combine our Reinforcements activities related to advanced composites with our previously reported Composites and Structures segments into a single organization, and explore the sale of our European Architectural business, our EBGI product lines and our interest in the TechFab joint venture, previously reported within the Reinforcements segment.



In December 2006, we completed the sale of our interest in TechFab LLC (“TechFab”) to our joint venture partner for $22.0 million in cash. TechFab is headquartered in Anderson, SC and manufactures non-woven reinforcement materials used in the manufacture of construction and roofing materials, sail cloth and other specialty applications. As a result of the sale, we recognized a after-tax gain of $9.6 million in the fourth quarter of 2006. The TechFab joint venture was part of our previously reported Reinforcements segment.



In February 2007, we completed the sale of our European Architectural business. Cash proceeds from the sale were $25.0 million. As a result of the sale, we recognized an after-tax gain of $6.5 million.



In August 2007, we completed the sale of the EBGI portion of our reinforcements business. Cash proceeds from the sale, net of transaction costs, were $58.5 million, resulting in a net after-tax loss of $3.4 million. The sale includes up to $12.5 million of additional payments contingent upon future sales of the Ballistics product line. Any additional payments will be recorded as income when earned.



With the completion of the EBGI sale, our previously announced portfolio review reached a successful conclusion, resulting in total cash proceeds, before any earnout payments, of $106.0 million and a net after-tax gain of $12.7 million.



In December of 2005, Hexcel and Dainippon Ink and Chemicals, Inc. (“DIC”) decided to dissolve the DIC-Hexcel Limited (“DHL”) joint venture. This joint venture was located in Komatsu, Japan, and produced and sold prepregs, honeycomb and decorative laminates using technology licensed from us and DIC. The dissolution was completed in the fourth quarter of 2006 with Hexcel receiving a cash distribution of $0.1 million. The DHL joint venture was part of our previously reported Composites segment.



See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 2 “Discontinued Operations” and Note 6 “Investments in Affiliated Companies” to the accompanying consolidated financial statements of this Annual Report on Form 10-K for further information related to the status of our strategic review, results from discontinued operations and information related to our joint ventures.



Financial Information About Segments and Geographic Areas



Financial information and further discussion of our segments and geographic areas, including external sales and long-lived assets, are contained under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 19 to the accompanying consolidated financial statements of this Annual Report on Form 10-K.



Significant Customers



Approximately 25%, 24%, and 23% of our 2007, 2006, and 2005 net sales, respectively, were to The Boeing Company (“Boeing”) and related subcontractors. Of the 25% of sales to Boeing and its subcontractors in 2007, 20.7% related to commercial aerospace market applications and 4.5% related to space and defense market applications. Approximately 22%, 26%, and 27% of our 2007, 2006, and 2005 net sales, respectively, were to European Aeronautic Defence and Space Company (“EADS”), including its business division Airbus Industrie (“Airbus”), and its subcontractors.

Commercial Aerospace



The commercial aerospace industry is our largest user of advanced composites. The economic benefits airlines can obtain from weight savings in both fuel economy and aircraft range, combined with the design enhancement that comes from the advantages of advanced composites over traditional materials, have caused the industry to be the leader in the use of these materials. While military aircraft and space craft have championed the development of these materials, commercial aerospace has had the greater consumption requirements and has commercialized the use of these products. Accordingly, the demand for advanced structural material products is closely correlated to the demand for commercial aircraft.



The use of advanced composites in commercial aerospace is primarily in the manufacture of new commercial aircraft. The aftermarket for these products is very small as many of these materials are designed to last for the life of the aircraft. The demand for new commercial aircraft is driven by two principal factors, the first of which is airline passenger traffic (the number of revenue passenger miles flown by the airlines) which affects the required size of airline fleets. According to the International Civil Aviation Organization, passenger traffic has grown at an annual compound rate of 5.5% from 1985 to 2006 and has seen year on year growth of 5.5% (estimate), 5.9% and 8.0% during 2007, 2006 and 2005, respectively. Growth in passenger traffic requires growth in the size of the fleet of commercial aircraft operated by airlines worldwide.



The second factor, which is less sensitive to the general economy, is the replacement rates for existing aircraft. The rates of retirement of passenger and freight aircraft, resulting mainly from obsolescence, are determined in part by the regulatory requirements established by various civil aviation authorities worldwide as well as public concern regarding aircraft age, safety and noise. These rates may also be affected by the desire of the various airlines to improve operating costs with higher payloads and more fuel-efficient aircraft (which in turn is influenced by the price of fuel) and by reducing maintenance expense. In addition, there is expected to be increasing pressure on airlines to replace their aging fleet with more fuel efficient and quieter aircraft to be more environmentally responsible. When aircraft are retired from commercial airline fleets, they may be converted to cargo freight aircraft or scrapped.



Each new generation of commercial aircraft has used increasing quantities of advanced composites, replacing metals. This follows the trend previously seen in military fighter aircraft where advanced composites may now exceed 50% of the weight of the airframe. Early versions of commercial jet aircraft, such as the Boeing 707, which was developed in the early 1950’s, contained almost no composite materials. One of the first aircraft to use a meaningful amount of composite materials, the Boeing 767 entered into service in 1983, and was built with an airframe containing approximately 6% composite materials. The airframe of Boeing’s 777 aircraft, which entered service in 1995, is approximately 11% composite. By comparison, the next generation of aircraft in development will contain significantly higher composite content by weight. The Airbus A380 which was certified in December 2006, is being built with an airframe containing approximately 23% composite by weight. The first aircraft was delivered in 2007. Boeing is starting to assemble the first 787 aircraft with a content of 50% or more composite materials by weight. Its maiden flight is expected in mid-2008 and the aircraft is projected to enter into service early in 2009. In December 2006, Airbus formally launched the A350 XWB also projected to have a composite content of 50% or more by weight. The A350 XWB is forecast to enter into service in 2013.



The impact of Boeing and Airbus’ production rate changes on us is typically influenced by two factors: the mix of aircraft produced and the inventory supply chain effects of increases or reductions in aircraft production. We have products on all Boeing and Airbus planes. The dollar value of our materials varies by aircraft type – twin aisle aircraft use more of our materials than narrow body aircraft and newer designed aircraft use more our materials than older generations. On average, for established programs we deliver products into the supply chain about six months prior to aircraft delivery. Depending on the product, orders placed with us are received anywhere between one and eighteen months prior to delivery of the aircraft to the customer. For aircraft that are in the ramp-up stage, such as the A380 and the B787, we will have sales as much as a few years in advance of the delivery. Increased aircraft deliveries combined with the secular penetration resulted in our commercial aerospace revenues increasing by approximately 14% and 16% in 2007 and 2006, respectively.

Commercial aerospace represented 53% of our 2007 net sales. Approximately 74% of these revenues can be identified as sales to Boeing, Airbus and their subcontractors for the production of commercial aircraft. The balance of our commercial aerospace sales are related to regional and business aircraft manufacture, and other commercial aircraft applications. Regional aircraft production has also increased over time, but does not directly follow the cycle of large commercial aircraft deliveries. These applications also exhibit increasing utilization of composite materials with each new generation of aircraft.



Industrial Markets



We group under this market segment revenue from applications for our products outside the aerospace and electronics markets. A number of these applications represent emerging opportunities for our products. In developing new applications, we seek those opportunities where advanced composites technology offer significant benefits to the end user, often applications that demand high engineering performance. Within this segment, the major end market sub-segments include, in order of size based on our 2007 sales, wind energy, general industrial applications, recreational equipment (e.g., bicycles, snowboards, tennis rackets and hockey sticks), and transportation (e.g., automobiles, mass transit and high-speed rail, and marine applications). Our participation in these market applications complements our commercial and military aerospace businesses, and we are committed to pursuing the utilization of advanced structural material technology where industrial customers can generate significant value.



Space & Defense



The space & defense market has historically been an innovator in the use of, and source of significant demand for, advanced composites. The aggregate demand by space and defense customers is primarily a function of procurement of military aircraft that utilize advanced composites by the United States and certain European governments. We are currently qualified to supply materials to a broad range of over 80 military aircraft and helicopter programs. The top ten programs by revenues represent less than 50% of our Space & Defense revenues. These programs include the F/A-18E/F Hornet, the F-22 Raptor, and the Eurofighter (Typhoon), as well as the C-17, the V-22 Osprey tiltrotor aircraft, and the Blackhawk, Tiger and NH90 helicopters. In addition, there are new programs in development such as the F-35 (Joint Strike Fighter or “JSF”), CH53K heavy lift helicopter and the EADS A400M military transport planned to enter production later in the decade. The benefits that we obtain from these programs will depend upon which are funded and the extent of such funding. Space applications for advanced composites include solid rocket booster cases, fairings and payload doors for launch vehicles, and buss and solar arrays for military and commercial satellites.



Contracts for military and some commercial programs may contain provisions applicable to both U.S. Government contracts and subcontracts. For example, under a termination for convenience clause, the prime contractors may flow down this clause to materials suppliers such as Hexcel. According to the terms of a contract, we may be subject to U.S. government Federal Acquisition Regulations, Department of Defense Federal Acquisition Regulations Supplement, Cost Accounting Standards, and associated procurement laws.



Further discussion of our markets, including certain risks, uncertainties and other factors with respect to “forward-looking statements” about those markets, is contained under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”



Backlog



In recent years, our customers have increasingly demanded shorter order lead times and “just-in-time” delivery performance. While we have many multi-year contracts with our major aerospace customers, most of these contracts specify the proportion of the customers’ requirements that will be supplied by us and the terms under which the sales will occur, not the specific quantities to be procured. Our industrial customers have always desired to order their requirements on as short a lead-time as possible. As a result, twelve-month order backlog is not a meaningful trend indicator for us, and therefore, we do not monitor it in the management of our business.



Raw Materials and Production Activities



Our manufacturing operations are vertically integrated. We produce carbon fibers, industrial fabrics, composite materials and composites structures as well as sell these materials to third-party customers for their use in the manufacture of their products.



We manufacture high performance carbon fiber from polyacrylonitrile (“PAN”) precursor produced at our Decatur, Alabama facility. The primary raw material for PAN is acrylonitrile. All the PAN we produce is for internal carbon fiber production. We consume approximately 55% by value of the carbon fiber we produce and sell the remainder of our output to third-party customers. However, as one of the world’s largest consumers of carbon fiber, we purchase significantly greater quantities of carbon fiber than we produce for our own use. The sources of carbon fiber we can use in any product or application are sometimes dictated by its customer qualifications or certifications, otherwise we select a fiber based on performance, price and availability. With the increasing demand for carbon fiber, particularly in aerospace applications, the supply of carbon fiber started to tighten in 2005. In response to increasing demand, the majority of carbon fiber manufacturers have announced plans to increase their manufacturing capacity over the next two to three years. In 2005, we announced our plans to expand our PAN and carbon fiber capacity by about 50% to serve the growing needs of our customers and our own downstream products. The first of the fiber lines was completed at the end of 2006 and production began in the first quarter of 2007. The second line, a greenfield site near Madrid, Spain, was essentially completed in December 2007 and will begin production by end of the first quarter of 2008. In October 2007, we announced another 70% increase in PAN and carbon fiber capacity, which will increase our nameplate capacity to a total of about 16 million pounds of carbon fiber by 2010. After a new line starts production, it can take over a year to be certified for aerospace qualifications. However, these lines can start supplying fiber for many industrial and recreational applications in a very short time period.



We purchase glass yarn from a number of suppliers in the United States, Europe and Asia. Aramid and high strength fibers are produced by only a few companies, and during periods of high demand, can be in short supply. In addition, epoxy and other specialty resins, aramid paper and aluminum specialty foils are used in the manufacture of composite products. When entering into multi-year contracts with aerospace customers, the business attempts to get back-to-back commitments from key raw material suppliers.



Our manufacturing activities are generally based on a combination of “make-to-order” and “make-to-forecast” production requirements. We coordinate closely with key suppliers in an effort to avoid raw material shortages and excess inventories. However, many of the key raw materials we consume are available from relatively few sources, and in many cases the cost of product qualification makes it impractical to develop multiple sources of supply. The lack of availability of these materials could under certain circumstances have a material adverse effect on our consolidated results of operations.



Research and Technology; Patents and Know-How



Research and Technology (“R&T”) departments support our businesses worldwide. Through R&T activities, we maintain expertise in precursor and carbon fiber, chemical and polymer formulation and curatives, fabric forming and textile architectures, advanced composite structures, process engineering, application development, analysis and testing of composite materials, computational design, and other scientific disciplines related to our worldwide business base.



Our products rely primarily on our expertise in materials science, textiles, process engineering and polymer chemistry. Consistent with market demand, we have been placing more emphasis on cost effective product design and lean manufacturing in recent years while seeking to improve the consistency of our products. Towards this end, we have entered into formal and informal alliances, as well as licensing and teaming arrangements, with several customers, suppliers, external agencies and laboratories. We believe that we possess unique capabilities to design, develop and manufacture composite materials and structures. We have over 400 patents and pending applications worldwide, have licensed many key technologies, and have granted technology licenses and patent rights to several third parties in connection with joint ventures and joint development programs. It is our policy to actively enforce our proprietary rights. We believe that the patents and know-how rights currently owned or licensed by Hexcel are adequate for the conduct of our business.



We spent $34.2 million, $29.7 million, and $24.8 million for R&T in 2007, 2006, and 2005, respectively. We increased our R&T spending in 2007 to support new product development and qualification activities particularly in relation to commercial aircraft applications. These expenditures were expensed as incurred.



Environmental Matters



We are subject to federal, state, local and foreign laws and regulations designed to protect the environment and to regulate the discharge of materials into the environment. We believe that our policies, practices, and procedures are properly designed to prevent unreasonable risk of environmental damage and associated financial liability. To date, environmental control regulations have not had a significant adverse effect on our overall operations.



Our aggregate environmental related accruals at December 31, 2007 and 2006 were $3.2 million and $5.3 million, respectively. As of December 31, 2007 and December 31, 2006, $2.1 million and $2.4 million, respectively, were included in other current accrued liabilities, with the remainder included in other non-current liabilities. As related to certain of our environmental matters, our accruals were estimated at the low end of a range of possible outcomes since there was no better point within the range. If we had accrued for these matters at the high end of the range of possible outcomes, our accruals would have been $4.6 million and $2.7 million higher at December 31, 2007 and 2006, respectively. Environmental remediation spending charged directly to our reserve balance for 2007, 2006, and 2005, was $2.7 million, $2.8 million, and $1.4 million, respectively. In addition, our operating costs relating to environmental compliance were $8.2 million, $8.0 million, and $6.5 million, for 2007, 2006, and 2005, respectively, and were charged directly to expense. Capital expenditures for environmental matters approximated $2.3 million, $0.8 million and $1.1 million for 2007, 2006 and 2005, respectively.



These accruals can change significantly from period to period due to such factors as additional information on the nature or extent of contamination, the methods of remediation required, changes in the apportionment of costs among responsible parties and other actions by governmental agencies or private parties, or the impact, if any, of Hexcel being named in a new matter. A discussion of environmental matters is contained in Item 3, “Legal Proceedings,” and in Note 16 to the accompanying consolidated financial statements included in this Annual Report on Form 10-K.



Sales and Marketing



A staff of salaried market managers, product managers and sales personnel sell and market our products directly to customers worldwide. We also use independent distributors and manufacturer representatives for certain products, markets and regions. In addition, we operate various sales representation offices in the United States, Europe and Asia Pacific.



Competition



In the production and sale of advanced composites, we compete with a number of U.S. and international companies on a worldwide basis. The broad markets for composites are highly competitive, and we have focused on both specific submarkets and specialty products within markets. In addition to competing directly with companies offering similar products, we compete with producers of substitute composites such as structural foam, infusion technology, wood and metal. Depending upon the material and markets, relevant competitive factors include approvals, database of usage, technology, product performance, delivery, service, price and customer preference for sole sourcing.

Employees

As of December 31, 2007, we employed 4,081 full-time employees, 2,212 in the United States and 1,869 in other countries. The number of full-time employees as of December 31, 2006 and 2005 was 4,459 and 4,460, respectively.

CEO BACKGROUND

DAVID E. BERGES has served as Chairman of the board of directors and Chief Executive Officer of Hexcel since July 2001, and was President of Hexcel from February 2002 to February 2007. Prior to joining Hexcel, Mr. Berges was President of the Automotive Products Group of Honeywell International Inc. from 1997 to July 2001 and Vice President and General Manager, Engine Systems and Accessories, at AlliedSignal Aerospace from 1994 to 1997. Previously Mr. Berges was President and Chief Operating Officer of Barnes Aerospace, a division of Barnes Group Inc. Mr. Berges spent the first fifteen years of his career in a variety of managerial and technical positions with the General Electric Company. Mr. Berges joined the board of directors of Dana Corporation in April 2004.

JOEL S. BECKMAN has been a director of Hexcel since March 2003, and is a member of Hexcel’s audit committee. Mr. Beckman is a Managing Partner of Greenbriar Equity Group LLC, a private equity fund focused exclusively on making investments in transportation and transportation-related companies. Prior to founding Greenbriar in 2000, Mr. Beckman was a Managing Director and Partner of Goldman, Sachs & Co., which he joined in 1981. Mr. Beckman is a member of the board of directors of American Tire Distributors, Inc., Stag-Parkway, Inc. and Western Peterbilt, Inc., a member of the Board of Trustees of the University of Rochester and is active in various civic organizations.

H. ARTHUR BELLOWS, JR. has been a director of Hexcel since December 2000. Mr. Bellows also serves as Chair of the audit committee and is a member of the nominating and corporate governance committee of Hexcel. He has served as Chairman of Braeburn Associates, a private merchant banking firm, since 1999, and Chairman of The Finance Network, a private financial services firm, since 1999. Mr. Bellows was President, Chief Operating Officer and a director of Audits & Surveys Worldwide, Inc., an international market research firm, from 1995 to March 1999, and continued to serve as a director until March 2002. In 1967, he founded The Triangle Corporation, a manufacturer of hand tools, aerosol chemicals, diagnostic equipment for automobiles and various hardware products, and served as its Chairman, President and Chief Executive Officer from its founding to March, 1995. Mr. Bellows is a member of the board of directors of Beacon Roofing Supply, Inc. and serves as chair of its audit committee, and is also an officer and director of various civic organizations.

LYNN BRUBAKER has been a director of Hexcel since December 2005, and is a member of the compensation committee of Hexcel. She recently retired after spending over 25 years in the aerospace industry in a variety of executive, operations, sales and marking and customer support roles. From 1999 until June 2005 she was Vice President/General Manager—Commercial Aerospace for Honeywell International, with her primary focus in that role being on business strategies and customer operations for Honeywell’s global commercial markets. From 1997 to 1999, Ms. Brubaker was Vice President Americas for Honeywell, and from 1995 to 1997, prior to AlliedSignal’s merger with Honeywell, she was Vice President, Marketing, Sales and Support Operations, for AlliedSignal. Prior to joining AlliedSignal, Ms. Brubaker held a variety of management positions with McDonnell Douglas, Republic (predecessor to Northwest Airlines), and Comair. Ms. Brubaker currently serves on the board of a variety of private companies and other business organizations.

JEFFREY C. CAMPBELL has been a director of Hexcel since November 2003, and is a member of the audit committee of Hexcel. Mr. Campbell has served as Executive Vice President and Chief Financial Officer of McKesson Corporation, a leading healthcare services, information technology and distribution company, since January 2004. Mr. Campbell was Senior Vice President and Chief Financial Officer of AMR Corp, the parent company of American Airlines, from June 2002 to December 2003, served as a Vice President of American Airlines from 1998 to June 2002 and served in various management positions of American Airlines from 1990 to 1998.

SANDRA L. DERICKSON has been a director of Hexcel since February 2002. Ms. Derickson is Chair of the nominating and corporate governance committee and is a member of the compensation committee of Hexcel. Ms. Derickson retired from HSBC in February 2007. She held several management positions at HSBC from September 2000 to February 2007 including President and Chief Executive Officer, HSBC Bank USA; Vice Chairman, HSBC Finance; and Group Executive, HSBC Finance. During her tenure, she was responsible for private label credit cards, insurance services, taxpayer services, auto financing and some of the Group’s mortgage businesses. From 1976 to 1999, Ms. Derickson held various management positions with General Electric Capital Corporation, the last of which was President of GE Capital Auto Financial Services. Ms. Derickson was also an officer of the General Electric Company.

W. KIM FOSTER has been nominated for election to the board at the annual meeting. Mr. Foster has served as Senior Vice President and Chief Financial Officer of FMC Corporation, a chemical manufacturer serving various agricultural, industrial and consumer markets, since 2001. Prior to serving in his current role, Mr. Foster held numerous other executive and management positions with FMC, including Vice President and General Manager—Agricultural Products Group from 1998 to 2001; Director, International, Agricultural Products Group from 1996-1998; and General Manager, Airport Products and Systems Division, 1991-1996.

DAVID C. HURLEY has been a director of Hexcel since November 2005, and is a member of the audit committee of Hexcel. He is currently the Vice Chairman of PrivatAir, a corporate aviation services company based in Geneva, Switzerland, where he served as Chief Executive Officer from 2000 to February 2003. Prior to 2000, Mr. Hurley was the Chairman and Chief Executive Officer of Flight Services Group (FSG), a corporate aircraft management and sales company, which he founded in 1984 and was acquired by PrivatAir in 2000. Before founding FSG, Mr. Hurley served as Senior Vice President of Domestic and International Sales for Canadair Challenger. He currently serves on the Boards of BE Aerospace, Inc., Genesee & Wyoming Inc., Genesis Lease Limited, Ionatron, Inc., ExelTech Aerospace, Inc., the Smithsonian Institution’s National Air and Space Museum and a variety of private companies.

DAVID L. PUGH has been a director of Hexcel since July 2006, and is a member of the compensation committee of Hexcel. Mr. Pugh has served as the Chairman of Applied Industrial Technologies Inc., one of North America’s leading industrial product distributors, since October 2000, and as Applied’s Chief Executive Officer since January 2000. He was President of Applied from 1999 to October 2000. Prior to joining Applied, Mr. Pugh was senior vice president of Rockwell Automation and general manager of Rockwell’s Industrial Control Group. Prior to joining Rockwell, Mr. Pugh held various sales, marketing and operations positions at Square D. Co. and Westinghouse Electric Corp. Mr. Pugh is a director of OM Group, Inc.

MANAGEMENT DISCUSSION FROM LATEST 10K

Business Trends



The primary markets we serve continued to grow in 2007, as our customers continue to expand their use of advanced composites. 2007 was our fourth consecutive year of sales growth, as our average annual sales growth rate from 2003 to 2007 was 13%.



• The commercial aerospace market continued to grow in 2007. The International Civil Aviation Organization estimates that global passenger traffic measured as revenue passenger kilometers increased by 5.5% in 2007. Boeing and Airbus have reported commercial aircraft net orders of 2,754, easily surpassing the figure of 1,834 in 2006. They made 894 new commercial aircraft deliveries, 7.5% higher that the 832 delivered in 2006 and 53% higher than the 2003 deliveries of 586. Both Boeing and Airbus expect to further increase deliveries in 2008.



• Reflecting the strength of our customers’ demand, our commercial aerospace sales increased by 14% in 2007 compared to 2006 (11% in constant currency). Boeing and its subcontractors, manufacturers of engines and nacelles, and regional aircraft producers as a group increased over 25% as compared to 2006. Airbus and its subcontractor sales ended down about 5% from the prior year, as the comparisons for the first half of 2007 were significantly impacted by the June 2006 announcement of the A380 delay. Our sales to the regional and business aircraft markets were also strong in 2007 with increases over 25% for the year.

• 2007 provided further confirmation of the longstanding trend of the commercial aerospace industry utilizing a greater proportion of advanced composite materials with each new generation of aircraft. Among the new aircraft orders received by Boeing and Airbus were orders for their new composite-rich aircraft, currently in development. Boeing has now recorded 857 orders and commitments for its 787 Dreamliner aircraft. Boeing has indicated that this aircraft will have at least 50% composite content by weight, including composite wings and fuselage, compared to the 11% composite content used in the construction of its 777 aircraft and 6% for the 767 the aircraft it is primarily replacing. The 787 is expected to enter into service early in 2009. Hexcel estimates that it has $1.0 million to $1.3 million of content per plane. In December 2006, Airbus announced the launch of the A350 XWB which they indicated will also have at least 50% composite content by weight. Airbus has received 320 orders to date for the A350, which is expected to enter into service by 2013. Meanwhile, the Airbus A380 has 23% composite content by weight and has more Hexcel material used in its production than any aircraft previously manufactured, approximately $3 million per plane. The first A380 was delivered to a customer in October 2007.



• With continued increases in aircraft production and the contribution of the A380 and B787 ramp-up, total 2008 commercial aerospace revenues are projected to grow in the 12% - 15% range as compared to 2007. The ramp-up of these new programs accelerate the secular penetration story for composites in commercial aerospace.



• Our Space and Defense sales of $255.7 million were 15.2% higher as compared to 2006 (12.5% in constant currency). Our sales in 2006 were essentially flat compared to 2005 as inventory adjustments at certain rotorcraft customers slowed revenue growth in 2006. Over the two year period our sales average annual growth was 8% per year, which is in line with historical levels and our expectations. We continue to benefit from our extensive qualifications to supply composite materials and, in some cases, composite structures to a broad range of military aircraft and helicopter programs around the world.



• Our Industrial sales of $293.6 million were 4.8% higher as compared to 2006 (1.7% lower in constant currency). Industrial sales include wind energy, general industrial applications, recreation and transportation. Wind energy growth was in the mid-teens for the year as compared to 2006 in constant currency, while capacity constraints, a weak winter sports market and selective portfolio pruning resulted in the other submarkets to decrease from the prior year.



• Led by the expected strong growth in wind energy revenues, Industrial sales growth should return to the mid-teens in 2008. After a weak year for recreational and “other industrial” sales, we expect modest growth for non-wind related sales.



• In total we anticipate 2008 consolidated revenues to grow in a range of 10% - 15% year on year, assuming the Euro and British Pound currency exchange rates for the year of 2008 are comparable to 2007.



Further information regarding our outlook for 2008 is contained in our Form 8-K dated December 6, 2007. This 8-K should be read in conjunction with the risk factor section included in this Form 10-K.



Portfolio Review


In July of 2006, we announced our intention to explore strategic alternatives for portions of our previously reported Reinforcements segment. In order to take full advantage of the many growing applications for advanced composite materials, we decided to narrow our focus and consolidate our activities around our carbon fiber, reinforcements for composites, honeycomb, matrix and engineered products product lines. In doing so, we decided to combine our Reinforcements activities related to advanced composites with our previously reported Composites and Structures segments into a single organization, and explore the sale of our European Architectural business, our EBGI product lines and our interest in the TechFab joint venture, previously reported within the Reinforcements segment.

In December of 2006, we completed the sale of our interest in TechFab LLC (“TechFab”) to our joint venture partner for $22.0 million in cash. TechFab is headquartered in Anderson, SC and manufactures non-woven reinforcement materials used in the manufacture of construction and roofing materials, sail cloth and other specialty applications. As a result of the sale, we recognized an after-tax gain of $9.6 million in the fourth quarter of 2006.

In February of 2007, we completed the sale of our European Architectural business. Cash proceeds from the sale were $25.0 million. As a result of the sale, we recognized an after-tax gain of $6.5 million.

On August 6, 2007, we completed the sale of the EBGI portion of our reinforcements business. Cash proceeds from the sale, net of transaction costs, were $58.5 million, resulting in a net after-tax loss of $3.4 million. The sale includes up to $12.5 million of additional earnout payments contingent upon annual sales for three years of the Ballistics product line. Any additional payments will be recorded as income when earned.


With the completion of the EBGI sale, our previously announced portfolio review has reached a successful conclusion, resulting in total cash proceeds, before any earnout payments, of $105.5 million and a net after-tax gain of $12.7 million.

Results of Operations



We have two reportable segments: Composite Materials and Engineered Products. Although these segments provide customers with different products and services, they often overlap within three end business markets: Commercial Aerospace, Industrial and Space & Defense. Therefore, we also find it meaningful to evaluate the performance of our segments through the three end business markets. Further discussion and additional financial information about our segments may be found in Note 19 to the accompanying consolidated financial statements of this Annual Report on Form 10-K.



2007 Compared to 2006



Net Sales: Consolidated net sales of $1,171.1 million for 2007 were $121.6 million, or 11.6% higher than the $1,049.5 million of net sales for 2006. The increase was primarily attributable to sales growth within Commercial Aerospace. Had the same U.S. dollar, British Pound Sterling and Euro exchange rates applied in 2006 as in 2007 (“in constant currency”), consolidated net sales for 2007 would have been $87.0 million, or 8.0% higher than 2006 net sales of $1,084.1 million (restated “in constant currency” using 2007 rates).

Commercial Aerospace : Net sales to the commercial aerospace market segment increased by $74.5 million or 13.6% to $621.8 million for 2007 as compared to net sales of $547.3 million for 2006. Net sales of the Composite Materials segment were $45.7 million higher, up 11.2% from 2006. Net sales of the Engineered Products segment increased by $28.8 million or 20.9% to $166.6 million in 2007. In constant currency, net sales to the commercial aerospace market segment increased $63.8 million, or 11.4%.



Our overall year-over-year improvement was driven by increases in aircraft production in 2007 by Boeing, Airbus, their subcontractors and other aircraft manufacturers, as well as the resultant growth in demand by aircraft engine and nacelle manufacturers. For the year, Boeing and its subcontractors, manufacturers of engines and nacelles, and regional aircraft producers as a group were up over 25% as compared to 2006. Airbus and its subcontractor sales ended down about 5% from the prior year, as the comparisons for the first half of 2007 were significantly impacted by the June 2006 announcement of the A380 delay.



We continue to pursue the increased use of advanced composite materials in each new generation of aircraft. Boeing and Airbus are currently developing the 787 and A350XWB aircraft, respectively, each of which employ higher percentage of advanced composite materials than any previous large commercial aircraft.



Industrial : Net sales of $293.6 million for 2007 increased by $13.4 million, or 4.8%, compared to net sales of $280.2 million in 2006. In constant currency, net sales to the industrial market segment decreased $5.2 million or 1.7%. This decrease was primarily due to lower revenues from recreation and automotive applications offset in part by strong growth in sales of composite materials used in wind energy applications.



Sales of composite materials used to manufacture wind turbine blades produced mid-teens percentage growth compared to 2006, and represents the largest contributor within our Industrial market segment. Sales to recreation and other industrial markets for the year were down 9.2% due to capacity constraints, selective portfolio pruning and a weak winter sports market.



Space & Defense : Net sales of $255.7 million increased $33.7 million, or 15.2%, for 2007 as compared to net sales of $222.0 million for 2006 . In constant currency, net sales increased $28.4 million, or 12.5% . Rotocraft sales across all geographic areas was the primary contributor to the sales growth and included a benefit from a change in recognition of tooling revenue 2007 in the amount of approximately $5 million. The revenues that we derive from military and space programs tend to vary period to period based on customer ordering patterns and manufacturing campaigns. We continue to benefit from our ability to supply composite materials and, in some cases, composite structures to a broad range of military aircraft and helicopter programs, including the F/A-18E/F (Hornet), the F-22 (Raptor), the European Fighter Aircraft (Typhoon), the C-17, the V-22 (Osprey) tilt rotor aircraft, and the Blackhawk, the Tiger and the NH90 helicopters. In addition, the EADS A400M military transport aircraft and the F-35 (joint strike fighter or JSF) are currently under development and should enter low rate initial production later in the decade .

Gross Margin: Gross margin for 2007 was $283.0 million, or 24.2% of net sales, compared to gross margin of $248.5 million, or 23.7% of net sales, in 2006. The improvement reflects primarily the contribution of higher net sales from Commercial Aerospace, Space & Defense and Wind Energy end markets, the product mix of those markets and improved operating effeciencies somewhat offset by higher maintenance, labor, freight and depreciation expenses.



Selling, General and Administrative (“SG&A”) Expenses: SG&A expenses were $114.0 million, or 9.7% of net sales, for 2007 compared with $105.5 million, or 10.1% of net sales, for 2006. The $8.5 million increase in SG&A expenses reflects, among other factors, $3.9 million attributed to changes in foreign exchange rates, an increase of $2.1 million for share-based compensation primarily from grants issued at the beginning of the year. The remaining is primarily due to general increases in incentive compensation, salaries and benefits and costs related to personnel changes.



Research and Technology Expenses: R&T expenses for 2007 were $34.2 million, or 2.9% of net sales, compared with $29.7 million, or 2.8% of net sales, for 2006. The $4.5 million increase was due to qualification costs (i.e. costs associated with certifying our products and processes to customer specifications) associated with the acceleration of opportunities for composites on new commercial aircraft programs including the Boeing 787 and investment in the development of new products and applications.



Business Consolidation and Restructuring Expenses: Business consolidation and restructuring expenses for 2007 were $7.3 million, compared with $9.9 million for 2006. The decrease is primarily attributable to the establishment of a $7.4 million accrual in the fourth quarter of 2006 related to our organizational realignment. The 2007 expense related to this program was $2.8 million. This decrease was offset by an increase of $2.9 million during 2007, related to our Livermore program.



Other Expense, Net: Other operating expense of $12.6 million during 2007 consists a $9.4 million pension settlement charge related to previously disclosed termination of our U.S. defined benefit plan, and a $3.2 million impairment charge related to certain purchased technology and fixed assets related to our portfolio realignment. We did not incur any costs classified as other operating expense in 2006.



Operating Income: Operating income for 2007 was $114.9 million compared with operating income of $103.4 million for 2006. Operating income as a percent of sales was 9.8% and 9.9% for 2007 and 2006 respectively. The $11.5 million increase in operating income is due in part to greater sales for 2007 and product mix of those sales resulting in an increase in gross margin, partially offset by other expense of $12.6 million in 2007 where there was no such expense in 2006, and increased SG&A and R&T expenses. One of the Company’s performance measures is operating income adjusted for non-recurring operating expenses and business consolidation and restructuring expenses, which is a non-GAAP measure. Adjusted operating income for the years ended December 31, 2007 and 2006 was $134.8 million and $114.5 million or 11.5% and 10.9% as a percentage of net sales, respectively. A reconciliation to adjusted operating income is provided on page 25.



Operating income for the Composite Materials segment increased $23.7 million or 19.9% to $142.8 million, as compared to $119.1 million for 2006. The increase in operating income is the result of an additional $83.7 million of segment revenue, slightly offset by a $3.2 million impairment charge from the write-off of previously acquired technology and certain related fixed assets. Operating income for the Engineered Products segment decreased by $0.5 million compared with 2006 to $21.3 million.



We did not allocate corporate operating expenses of $49.2 million and $35.8 million to segments in 2007 and 2006, respectively. The year-on-year increase in corporate operating expenses of $13.4 million is primarily attributable to the pension settlement expense of $9.4 million and inceased SG&A of $4.0 million from the higher stock and incentive compensation costs and the costs related to personnel changes.



Interest Expense: Interest expense for 2007 was $21.4 million compared to $23.6 million for 2006. The $2.2 million decrease primarily due to lower average outstanding debt under our senior secured credit facility resulting in a $2.8 million decrease in expense and lower bank fees of $0.7 million. This decrease was partially offset by a $0.5 million increase in expense related to uncertain tax positions and a $0.7 million decrease in capitalized interest.



Non-Operating Expense, Net: Non-operating expense for 2007 was $1.1 million and in 2006 it was $0.1 million. Amounts reflect the accelerated amortization of deferred financing costs as a result of prepayments of the Company’s bank term loan with the net proceeds from asset sales.



Provision (Benefit) for Income Taxes : During 2007, we recorded a tax provision $33.4 million or 36.1% of pre-tax income. During the fourth quarter of 2007, we recorded a $1.9 million benefit, which includes an adjustment of $2.3 million to certain prior period balances to primarily record additional deferred tax assets arising from state net operating loss carryforwards, offset by other discrete items of $0.4 million. Excluding this benefit the effective tax rate for the year was 38.2%. The 2006 provision included a $4.5 million benefit for the reversal of a valuation allowance against our U.S. deferred tax assets related to capital losses.



As of December 31, 2007, there is a $7.7 million valuation allowance related to current and prior year net operating losses generated by our Belgian and certain UK subsidiaries. Consistent with prior years, we continue to adjust our tax provision rate through the establishment, or release, of a non-cash valuation allowance attributable to current Belgian and certain UK net operating income (losses). This practice will continue until such time as the Belgian and UK operations have evidenced the ability to consistently generate sufficient taxable income such that in future years management can reasonably expect that the deferred tax assets can be utilized.

Equity in Earnings from and Gain on Sale of Investments in Affiliated Companies: Equity in earnings from and gain on sale of investments in affiliated companies during 2007 of $4.3 million decreased by $15.6 million from 2006 due to the inclusion of a pre-tax gain of $15.7 million from the sale of our interest in TechFab LLC during 2006 to our joint venture partner for $22.0 million in cash. For additional information, see Note 6 to the accompanying consolidated financial statements of this Annual Report on Form 10-K.



Income from Continuing Operations : Net income from continuing operations was $63.3 million, or $0.66 per diluted share for the year ended December 31, 2007 compared to $64.9 million, or $0.68 per diluted common share for the year ended December 31, 2006. The decrease reflects the results discussed above.



Income (Loss) from Discontinued Operations, Net : Net loss from discontinued operations was $2.0 million, or $0.02 per diluted common share for the year ended December 31, 2007, which includes a net gain of $3.1 million related to the sales of the U.S. EBGI product lines and the European Architectural business. For the year ended December 31, 2006, our discontinued operations resulted in net income of $1.0 million, or $0.01 per diluted common share. The change in results from discontinued operations, excluding the 2007 gain on sales, was $6.1 million, primarily resulting from an after-tax charge of $9.7 million recognized during 2007 related to a litigation settlement. Our net gain on the sales of discontinued businesses consists of a $6.5 million gain on the sale our Architectural business and a $3.4 million loss on the sale of our U.S. EBGI product lines. For additional information, see Note 2 to the accompanying consolidated financial statements of this Annual Report on Form 10-K.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Results of Operations


Net Sales: Net sales of $281.1 million for the third quarter of 2007 were $28.8 million, or 11.4%, higher than the $252.3 million of net sales for the third quarter of 2006. The increase was primarily driven by continued strong sales to most of the Commercial Aerospace market. Had the same U.S. dollar, British pound sterling and Euro exchange rates applied in the third quarter of 2006 as in the third quarter of 2007, net sales for the third quarter of 2006 would have been $259.3 million, resulting in third quarter of 2007 sales being 8.4% higher than the third quarter of 2006 on a constant currency basis.

Third quarter 2006 data has been reclassified for purposes of comparison to our operating segments, redefined as of January 1, 2007 to reflect our strategic and operational realignment and to focus on advanced structural materials. In addition, we have reclassified certain of our reinforcement for composites product sales between markets to reflect improvements in the tracking of sales to end market applications and have reclassified our remaining European electronics sales to the Industrial market. The reclassification of certain reinforcement for composite revenues resulted in the movement of about $17.9 million of commercial aerospace sales to industrial and space & defense markets for the third quarter of 2006. This reclassification did not impact our previously reported Airbus and Boeing commercial aircraft sales.



Commercial Aerospace : Net sales increased $20.8 million, or 15.8%, to $152.8 million for the third quarter of 2007, as compared to net sales of $132.0 million for the third quarter of 2006. The sales growth was led by revenues to Boeing and its subcontractors and to the regional and business jet markets, reflecting increased aircraft production, growth in demand for aircraft engine and nacelle manufactures, as well as the new Boeing 787. Sales to these customers were up over 25% year-on-year for the third quarter in a row. Sales to Airbus and its subcontractors were down less than 5% for the quarter as compared to the third quarter of 2006 due to the continued delay of the A380 program. While it remains difficult to forecast how Airbus and each of its many subcontractors will work through their inventory, we do expect A380 sales will begin to show growth starting in the fourth quarter of 2007. Foreign exchange rates contributed $2.4 million to commercial aerospace sales in the third quarter of 2007.



Industrial : Net sales of $67.9 million for the third quarter of 2007 were up 1.2% as compared to the net sales of $67.1 million for the third quarter of 2006. The industrial market consists primarily of wind, recreation, auto and other industrial sub-markets. The wind market had strong double digit sales growth compared to the third quarter of 2006. While our current wind business is primarily in Europe, global demand remains strong and we are in the process of adding manufacturing capacity in China to meet regional growth. This capacity should be available for production starting in the third quarter of 2008. Strong sales performance in wind energy markets was more than offset by weaker sales from recreation, automotive and other industrial markets. The European winter recreation market remains low, while other industrial sales were lower than last year as we continue to refine our focus on selected customers and applications. Foreign exchange rates contributed $3.7 million to industrial sales in the third quarter of 2007.



Space & Defense : Net sales to this market for the third quarter of 2007 were $60.4 million, an increase of $7.2 million, or 13.5%, when compared to the third quarter of 2006, as the increase is attributed to demand from military fixed wing and rotor craft applications. Foreign exchange rates contributed $0.9 million to space & defense sales in the third quarter of 2007.



Gross Margin : Gross margin for the third quarter of 2007 was $66.9 million, or 23.8% of net sales, compared with $57.3 million, or 22.7% of net sales, for the same period in 2006. The increase in gross margin reflects the contribution of higher net sales, the product mix of those sales and improved operating yields. Depreciation and amortization expense, included in cost of sales, for the third quarter of 2007 was $9.2 million compared to $8.1 million in the third quarter of 2006.



Selling, General and Administrative Expenses (“SG&A”): SG&A expenses of $26.4 million for the third quarter of 2007 were $0.3 million higher than the third quarter of 2006. SG&A expenses were 9.4% and 10.3% of net sales for the third quarters of 2007 and 2006, respectively. The third quarter of 2006 included an accrual of $2.0 million for environmental remediation costs. The year-over-year increase in SG&A expenses includes the impact of exchange rates and costs incurred related to personnel changes.



Research and Technology Expenses (“R&T”): R&T expenses for the third quarter of 2007 were $7.7 million, or 2.7% of net sales, compared with $6.8 million, or 2.7% of net sales, for the third quarter of 2006. The year-over-year increase in R&T expenses reflects the increase in qualification activities for new programs (i.e. costs associated with certifying our products and processes to customer aerospace specifications), including increased spending within the Engineered Products operating segment as a result of certification testing of Boeing 787 components made from the new HexMC system.



Operating Income: Operating income was $30.2 million, or 10.7% of net sales, in the third quarter of 2007, compared with $23.9 million, or 9.5% of net sales, in the third quarter of 2006. Operational performance and increased volumes drove the improved result year on year. Activity levels for the Company remain extremely high. Aerospace qualification processes are underway in a number of locations including our new carbon fiber precursor line in Decatur, AL; a new prepreg facility in Stade, Germany; the new carbon fiber line in Salt Lake City, UT; and for prepreg products transferred as part of the Livermore, CA closure. We are also opening new satellite prepreg facilities in Nantes, France and Tianjin, China to be close to our customers. The training of new Spanish employees continues in order to assure a timely start-up of our carbon fiber facility in the Illescas, Spain early next year.



Operating income for the Composite Materials operating segment was $33.9 million in the third quarter of 2007, a $4.3 million increase as compared to the third quarter of 2006, primarily due to the favorable impact of higher sales volumes and better variable operating margins. Operating income for the Engineered Products operating segment was $4.9 million in the third quarter of 2007, a $0.2 million increase as compared to the third quarter of 2006. This favorable impact is primarily due to improved sales volumes offset by increased restructuring and R&T expenses of $0.9 million. The decrease in Corporate operating expenses of $1.8 million is due to environmental remediation costs incurred during 2006 of $2.0 million.



Interest Expense: Interest expense was $5.3 million for the third quarter of 2007, compared to $5.7 million for the third quarter of 2006. The $0.4 million decrease in interest expense is due to a $0.7 million decrease from lower borrowings as a result of lower average outstanding debt during the period, partially offset by lower capitalized interest expense of $0.3 million, as a result of completing parts of the carbon fiber capacity expansion.



Non-Operating Expense: During the third quarter of 2007, we made mandatory principal prepayments on the term loan portion of our Senior Secured Credit Facility of $51.4 million as a result of net proceeds received from the sale of the EBGI business. As a result of the prepayment, we recorded a $0.5 million loss on the accelerated write-off of deferred financing costs from the early retirement of debt.

Provision for Income Taxes: The provision for income taxes for the third quarter of 2007 was $7.2 million, or 29.5% of income before income taxes. This compares to the provision for income taxes of $4.0 million, or 22.0% of income before taxes in the third quarter of 2006. The increase in the effective tax rate was primarily due to the reversal of $3.6 million of valuation allowance on certain U.S. deferred tax assets during the third quarter of 2006. The tax provision for third quarter of 2007 includes the reversal of $1.1 million of previously unrecognized tax benefits related to a favorable tax agreement reached with the UK tax authorities.



Equity in Earnings of Affiliated Companies: Equity in earnings of affiliated companies for the third quarter of 2007 was $0.9 million, compared to $1.0 million in the third quarter of 2006. In December 2006 we sold our interest in TechFab LLC, the reduction in equity in earnings from this sale, was partially offset by improved operating performance at our joint ventures in China and Malaysia. Equity in earnings of affiliated companies does not affect the Company’s cash flows. For further information, see Note 13 to the accompanying condensed consolidated financial statements.



Income from Continuing Operations: Net income from continuing operations was $18.1 million, or $0.19 per diluted share for the quarter ended September 30, 2007 compared to $15.2 million, or $0.16 per diluted share for the quarter ended September 30, 2006. The increase of $2.9 million is due to the factors discussed above.



Loss from Discontinued Operations, Net: Loss from discontinued operations, including the loss on sale of the EBGI business, was $0.8 million for the third quarter of 2007, compared to a gain of $0.5 million for the third quarter of 2006. The income from discontinued operations, net of tax, was $1.6 for the quarter compared to $0.5 last year. The loss on the sale of the discontinued operations totaled $2.4 million in the quarter, which includes a pre-tax curtailment gain of $1.7 million on the EBGI post-retiree medical plan, representing 100% of the unrecognized prior service cost as of August 1, 2007.

Results of Operations


Net Sales: Net sales of $853.4 million for the first nine months of 2007 were $66.8 million, or 8.5%, higher than the $786.6 million of net sales for the first nine months of 2006. The increase was driven by growth in our markets. Had the same U.S. dollar, British pound sterling and Euro exchange rates applied in the first nine months of 2006 as in the first nine months of 2007, net sales for 2006 would have been $809.4 million, resulting in a 5.4% increase on a constant currency basis.



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