Finally, over the past year Hexcel faced challenges in the carbon fiber market, where demand for aerospace grade fiber (Hexcel’s core carbon fiber product) has been at reduced levels. These reduced rates of production reflect the Asian effect on commercial aerospace production, customer productivity improvement and the reduction of excess inventories carried by military and space customers that were created during a recent period of carbon fiber shortages. Our ability to sell our surplus capacity to markets with less stringent product specifications has been limited by the recent increases in global manufacturing capacity for carbon fibers. These factors resulted in our carbon fiber business operating at about 50% of capacity in 1999 versus 90% of capacity the prior year. The resulting impact on Hexcel’s performance has been significant, but we expect aerospace demand to grow substantially over the next few years with the anticipated build up in military and space programs. Likewise, we expect further growth in our carbon fiber production as Hexcel expands the use of its fibers in additional commercial aerospace products.

Hexcel’s response to market fluctuations has been, and continues to be proactive. Indeed, we have successfully reduced overall costs, improved operational effectiveness, reduced debt and sharpened the focus on our core businesses. As outlined below, our response to these market challenges is founded upon the principles of business consolidation, Lean Enterprise initiatives and debt reduction.

Hexcel’s Responses

Business Consolidation—Comprehensive plans were initiated to reduce both selling and administrative expenses, as well as manufacturing costs. Our business units have been reorganized on a global versus a regional basis and manufacturing capacity has been consolidated to reduce surplus and concentrate on regional centers of manufacturing excellence. These actions are expected to produce ongoing savings of approximately $40 million per year by 2001. A portion of these savings has already been achieved.

Lean Enterprise—Not only are we reducing the size of our manufacturing infrastructure, but we are trying to fundamentally change the way we manufacture our products. Hexcel’s Lean Enterprise initiatives are a long-term plan to improve asset utilization, reduce costs and improve quality and operating efficiencies. Our efforts have already resulted in significant reductions in inventory and improved product quality. This is an ongoing commitment by the company to be a top performer in product quality and cost.

Debt Reduction—We are committed to strengthening our balance sheet through generating free cash flow to repay debt. In 1999 we reduced Hexcel’s debt by $86 million and, as a result, exceeded our goal of generating $100 million in free cash flow over the five quarter period ended December 31, 1999. Our Lean Enterprise initiatives aided the achievement of these goals with a reduction in inventory of approximately $60 million, or 30% in 1999. While reductions of this magnitude cannot be achieved each year, cash generation remains an area of emphasis for the company.

Outlook

We believe the above actions are substantial, comprehensive and will be effective in addressing the market challenges outlined earlier in this letter. The outlook for our markets beginning in 2001 appears more favorable. Over the next five years, we expect substantial growth in both our electronics and space and defense markets. Electronics will be driven by the significant growth forecasted in personal electronic devices and Internet hardware related products. Demand for fiberglass electronic materials is expected to substantially outperform GDP growth and possibly achieve double-digit annual growth for lightweight fabrics. In the space and defense markets we are also expecting strong five year growth owing to Hexcel’s broad position on most US and European military programs. While funding cornmitments for the military budget will always be a political decision, we believe that most, if not all of the new military aircraft programs currently completing their development will be funded and enter into full rate production.

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