UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

For the transition period from                     to                    

Commission File Number 1-8472

Hexcel Corporation

(Exact name of registrant as specified in its charter)

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

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

Large Accelerated Filer    x  Accelerated Filer    o  Non-Accelerated Filer  o

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

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

HEXCEL CORPORATION AND SUBSIDIARIES

INDEX

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PART I.  FINANCIAL INFORMATION

ITEM 1.  Condensed Consolidated Financial Statements (Unaudited)

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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Hexcel Corporation and Subsidiaries

Condensed Consolidated Statements of Operations

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Hexcel Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

The accompanying notes are an integral part of these condensed consolidated financial statements.

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HEXCEL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 – Significant Accounting Policies

In these notes, the terms “Hexcel”, “we,” “us,” or “our” mean Hexcel Corporation and subsidiary companies.

The accompanying condensed consolidated financial statements represent the consolidation of Hexcel.  Refer to Note 1 to the consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2006 for a discussion of our significant accounting policies.  The significant accounting policies included below are provided as a clarification to Note 1 to the consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2006.

Revenue Recognition

Product sales are recognized when all significant contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured, which is generally at the time of shipment.  Revenue is recognized on bill and hold arrangements only when the following criteria are met: risk of ownership has passed to the buyer, a fixed written commitment has been provided by the buyer, the goods are complete and ready for shipment and segregated from inventory, no performance obligations remain and a schedule for delivery of the goods has been established.  Revenues derived from design, installation and support services are recognized when the service is provided.  We accrue for sales returns and allowances based on its historical experience at the time of sale.

Property, Plant and Equipment

Property, plant and equipment, including capitalized interest applicable to major project expenditures, are recorded at cost.  Asset and accumulated depreciation accounts are relieved for dispositions, with resulting gains or losses reflected in earnings.  Depreciation of plant and equipment is provided using the straight-line method over the estimated useful lives of the various assets.  The estimated useful lives range from 10 to 40 years for buildings and improvements and from 3 to 20 years for machinery and equipment. Repairs and maintenance are expensed as incurred, while major replacements and betterments are capitalized and depreciated over the remaining useful life of the related asset.

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared from the unaudited 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 necessary for a fair presentation of financial position, results of operations and cash flows for the interim periods presented.  The condensed consolidated balance sheet as of December 31, 2006 was derived from the audited 2006 consolidated balance sheet.  Interim results are not necessarily indicative of results expected for any other interim period or for the full year.  The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis and the financial statements and notes thereto included in the Hexcel Corporation’s 2006 Annual Report on Form 10-K.

Certain prior period amounts in the condensed consolidated financial statements and accompanying notes have been reclassified to conform to the 2007 presentation.

New Accounting Standards

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment of FASB Statement No. 115 (“FAS 159”).  FAS 159 permits an entity to measure certain financial assets and financial liabilities at fair value.  The Statement’s objective is to improve financial reporting by allowing entities to mitigate volatility in reported earnings caused by the measurement of related assets and liabilities using different attributes, without having to apply complex hedge accounting provisions.  Entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date.  The new Statement establishes presentation and disclosure requirements to help financial statement users understand the effect of the entity’s election on its earnings, but does not eliminate disclosure requirements of other accounting standards.  FAS 159 is effective for fiscal years beginning after November 15, 2007 (as of January 1, 2008 for calendar year companies).  We are currently in the process of evaluating the effects of the adoption of FAS 159 on our consolidated results of operations, cash flows, and financial position.

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In September 2006, the FASB finalized Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“FAS 157”), which will become effective in 2008. This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements; however, it does not require any new fair value measurements. The provisions of FAS 157 will be applied prospectively to fair value measurements and disclosures in our condensed consolidated financial statements beginning in the first quarter of 2008.  We are currently evaluating the impact of FAS 157 on our results of operations, cash flows, and financial position.

Note 2 – Discontinued Operations

EBGI

On August 6, 2007, we completed the sale of the U.S. electronics, ballistics and general industrial product lines (“EBGI”) portion of our reinforcements business.  Net cash proceeds from the sale were $58.5 million (after related expenses), resulting in a net after-tax loss of $2.1 million.  Included within the loss on sale is an after-tax curtailment gain of $1.1 million, representing the unrecognized prior service cost on the EBGI Postretirement Health Care Plan as of August 6, 2007.  The sale of EBGI included the sale of the design, manufacturing, and selling activities and the related property, plant and equipment and working capital.  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.   In accordance with the provisions of FAS 144, the EBGI business, including the net after-tax loss on sale, has been reported as a discontinued operation in our accompanying condensed consolidated financial statements.

Revenues associated with the EBGI business were $16.8 million and $108.7 million for the quarter and nine-months ended September 30, 2007, respectively, and were $30.9 million and $107.3 million for the quarter and nine-months ended September 30, 2006, respectively.  During the second quarter of 2007, Hexcel established a pre-tax reserve of $15 million ($9.7 million after-tax) relating to the previously disclosed investigation by the U.S. Department of Justice into the use of allegedly defective Zylon fiber in ballistic vests purchased under U.S. government funded programs.  On October 29, 2007 we entered into a settlement agreement for the reserved amount of $15 million, which we paid on November 5, 2007.  Pre-tax loss associated with the discontinued operation was $2.5 million and $13.3 million (including a pre-tax loss on the sale of the business of $3.3 million) for the quarter and nine-months ended September 30, 2007, and break-even and $1.6 million for the quarter and nine-months ended September 30, 2006, respectively.

The following is a summary of the EBGI net assets sold as initially determined at December 31, 2006 and finally reported on the closing date of August 6, 2007:

Architectural Business

On February 28, 2007, we completed the sale of our European Architectural business.   The Architectural business sold included the design, manufacturing and selling activities and the related property, plant and equipment and working capital.  Net cash proceeds from the sale were $25.0 million, resulting in a net after-tax gain of $6.5 million, including a loss of $0.3 recorded in the third quarter of 2007.  In accordance with the provisions of FAS 144, the operations of the Architectural business, including the net after-tax gain on the sale, has been reported as a discontinued operation in our accompanying condensed consolidated financial statements.

Revenues associated with the Architectural business were $4.4 million for the quarter ended March 31, 2007 and $6.0 million and $18.2 million for the quarter and nine-months ended September 30, 2006, respectively.  Pre-tax income associated with the

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discontinued operation was $10.8 million (including a pre-tax gain on the sale of the business of $10.5 million) for the nine-months ended September 30, 2007 and $0.8 million and $2.4 million for the quarter and nine-months ended September 30, 2006, respectively.

The following is a summary of the net assets sold relating to the Architectural business as initially determined at December 31, 2006 and finally reported on the closing date of February 28, 2007:

Note 3 – Stock-Based Compensation

Stock-based compensation expense was $1.4 million and $1.6 million for the quarters ended September 30, 2007 and 2006, respectively.  Stock-based compensation expense was $8.1 million and $6.9 million for the nine-months ended September 30, 2007 and 2006, respectively.  Stock-based compensation expense capitalized for the quarters and nine-months ended September 30, 2007 and 2006 was not material.  During the nine-month periods ended September 30, 2007 and 2006, cash received from stock option exercises and employee stock purchases was $12.6 million and $7.6 million, respectively.  We used $1.8 million and $3.3 million in cash related to the shares withheld to satisfy employee tax obligations for restricted stock units (“RSUs”) and performance accelerated restricted stock units (“PARs”) converted during the nine-month period ended September 30, 2007 and 2006, respectively.  We realized excess tax benefits of $6.3 million and $6.2 million in connection with stock options exercised, and RSUs and PARs converted during the nine-month period ended September 30, 2007 and 2006, respectively.

Restricted Stock Units

The following activity occurred with respect to our outstanding restricted stock units and performance restricted stock units during the quarter and nine-months ended September 30, 2007:

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As of September 30, 2007, there was total unrecognized compensation cost related to nonvested RSUs and PRSUs of $5.7 million, which is expected to be recognized generally over the remaining vesting period ranging from one year to three years.

Stock Options

A summary of nonqualified stock option activity under out stock compensation plan for the nine-month period ended September 30, 2007 is as follows:

The total intrinsic value of options exercised during the quarter and nine-month period ended September 30, 2007 was $9.5 million and $17.7 million, respectively.  As of September 30, 2007, there was total unrecognized compensation cost related to nonvested stock options of $3.0 million, which is expected to be recognized generally over the remaining vesting period ranging from one year to three years.

Valuation Assumptions in Estimating Fair Value

We estimated the fair value of stock options at the grant date using the Black Scholes option pricing model with the following assumptions:

Retirement Provisions

Employees who terminate employment other than for “cause” (as defined in the relevant employee option agreement), and who meet the definition of retirement in the relevant employee option agreement (age 65 or age 55 with 5 or more years of service with the Company), will continue to have their options vest in accordance with the vesting schedule set in the option agreement.  Similar retirement provisions also apply to RSUs and PRSUs.  RSUs are deemed to be vested when an employee reaches their defined retirement age.  PRSUs differ from RSUs as an employee who is retirement eligible is only entitled to a pro-rata portion of their shares based on the portion of the performance period elapsed prior to retirement; however, if employed at the end of the performance period they are entitled to the entire grant.  As a result of these provisions, under the terms of SFAS 123(R), we have accelerated the recognition of the compensation expense for any employee who received a grant in 2007, or 2006 and who met the above definition

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of retirement eligibility, or who will meet the definition during the vesting period.  This results in the majority of stock-based compensation expense being recognized in the quarter which the grant occurs.

Shares Authorized for Grant

As of September 30, 2007, an aggregate of 3.4 million shares were authorized for future grant under our stock plan, which covers stock options, RSUs, PRSUs and PARS.

Employee Stock Purchase Plan (“ESPP”)

In addition, we maintain an ESPP, under which eligible employees may contribute up to 10% of their base earnings toward the quarterly purchase of our common stock at a purchase price equal to 85% of the fair market value of the common stock on the purchase date.  As of September 30, 2007, the number of shares of common stock reserved for future issuances under the ESPP was 0.2 million.

Note 4 – Inventories, net

Note 5 – 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. 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.   In December 2006, our Board of Directors voted to terminate the U.S. qualified defined benefit plan as of April 1, 2007, subject to appropriate regulatory approval.  As final termination of the U.S. qualified plan is expected to occur in the next twelve months, we have classified all liabilities of the plan as current.  Refer to our 2006 Annual Report on Form 10-K for further information regarding these plans.

Defined Benefit Retirement Plans

Net Periodic Benefit Costs

Net periodic benefit costs of our defined benefit retirement plans for the quarters and nine-months ended September 30, 2007 and 2006 were as follows:

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Contributions

We contributed $0.7 million and $0.2 million to our U.S. qualified and nonqualified defined benefit retirement plans during the third quarters of 2007 and 2006, respectively.  Contributions were $2.7 million and $1.9 million for the nine-months ended September 30, 2007 and 2006, respectively.  We expect to contribute at the minimum funding amount required in 2007, fund lump-sum payments and possibly fund the entire plan obligation by December 31, 2007, if the U.S. qualified plan’s termination is approved by the appropriate regulatory authorities during 2007.  Absent final plan termination in 2007, we plan to contribute approximately $3 million during 2007 to our U.S. qualified pension plan to fund expected lump sum payments.  Upon final termination of the U.S. qualified plan, we estimate that the final cash settlement contribution will be in the range of $10 million to $11 million and that we will record a pre-tax loss of approximately $12 million related to the unrecognized actuarial loss.  The termination will also result in the Company reducing its net periodic benefit cost by approximately $2 million per year.

We generally fund our U.S. nonqualified defined benefit retirement plans when benefit payments are incurred.  Under the provisions of these non-qualified plans, we expect to contribute $0.3 million in 2007 to cover unfunded benefits.  We contributed $2.6 million to our U.S. defined benefits retirement plans during the 2006 fiscal year. Accrued benefit costs for the U.S. defined benefit retirement plans as of September 30, 2007 were $21.9 million, of which $9.3 million is included within accrued liabilities and $12.6 million is included within other non-current liabilities.  Accrued benefit costs for the U.S. defined benefit retirement plans as of December 31, 2006 were $22.9 million, of which $0.3 million is included within accrued liabilities and $22.6 million is included within other non-current liabilities.

In addition, we contributed $0.7 million and $0.9 million to our European defined benefit retirement plans in the third quarters of 2007 and 2006, respectively.  Total contributions were $2.1 million and $2.6 million for the nine-months ended September 30, 2007 and 2006, respectively.  Meeting governing requirements, we plan to contribute approximately $2.6 million during 2007 to our European plans.  We contributed $2.6 million to our European plans during the 2006 fiscal year. Accrued benefit costs for the European defined benefit retirement plans as of September 30, 2007 were $38.3 million, of which $1.2 million is included within accrued liabilities and $37.1 million is included within other non-current liabilities.  Accrued benefit costs for the European defined benefit retirement plans as of December 31, 2006 were $37.6 million, of which $0.6 million is included within accrued liabilities and $37.0 million is included within other non-current liabilities.

Postretirement Health Care and Life Insurance Benefit Plans

Net Periodic Postretirement Benefit Costs

Net periodic benefit costs of our postretirement health care and life insurance benefit plans were $0.1 million, consisting of interest costs for the third quarter of 2007.  For both the nine-month periods ended September 30, 2007 and 2006, net periodic postretirement benefit costs were $0.4 million.

Contributions

In connection with our postretirement plans, we contributed $0.1 million and $0.3 million during the third quarters of 2007 and 2006, respectively, and $0.7 million and $0.8 million during the nine-months ended September 30, 2007 and 2006, respectively.  We periodically fund our postretirement plans to pay covered expenses as they are incurred.  Under the provisions of these post retirement plans, we expect to contribute approximately $1.0 million in 2007 to cover unfunded benefits.  We contributed $1.0 million to our postretirement plans during the 2006 fiscal year. Accrued benefit costs for the postretirement plans as of September 30, 2007 were $12.4 million, of which $0.6 million is included within accrued liabilities and $11.8 million is included within other non-current liabilities.  Accrued benefit costs for the postretirement plans as of December 31, 2006 were $11.5 million, of which $0.6 million is included within accrued liabilities and $10.9 million is included within other non-current liabilities.

Note 6 - Business Consolidation and Restructuring Programs

The aggregate business consolidation and restructuring liabilities as of September 30, 2007 and December 31, 2006, and activity for the quarter and nine-months ended September 30, 2007, consisted of the following:

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December 2006 Program

In December 2006, we announced that an organizational realignment process had begun to reorganize ourselves into a single business as well as address stranded costs resulting from divestitures associated with our portfolio realignment.  In connection with this action, we incurred severance and relocation expenses.  We expect this program will be substantially completed by December 31, 2007.

Business consolidation and restructuring liabilities as of September 30, 2007 and December 31, 2006, and activity for the December 2006 program for the quarter and nine-months ended September 30, 2007, consisted of the following:

Livermore Program

In the first quarter of 2004, we announced our intent to consolidate the activities of our Livermore, California facility into other facilities, principally the Salt Lake City, Utah plant.  During the quarter and nine-months ended September 30, 2007, we recognized $1.4 million and $2.9 million of expense, respectively, associated with the facility closures and consolidation activities that were expensed as incurred.  During the quarter and nine-months ended September 30, 2007, we made cash payments of $1.5 and $4.3 million, respectively, related to employee severance and facility closures and consolidation activities.  The plant ceased operations on March 31, 2007.  The Livermore facility has now been dismantled and the site is being remediated as part of the preparation for the sale of the property, with the related costs being expensed as incurred.  As of September 30, 2007, the accrued balance related to this program of $0.4 million is for severance obligations and is adequate for the estimated future requirements related to the program.

November 2001 Program

In November 2001, we announced a program to restructure business operations as a result of reductions in commercial aircraft production rates and due to depressed business conditions in the electronics market.  There was minimal activity in the program during the quarter and the year as this program is substantially complete.  During the nine-months ended September 30, 2007, we made cash payments of $0.2 million, related to employee severance and lease obligations.  We also reduced our estimate of future severance obligations under the program by $0.5 million for the nine-months ended September 30, 2007.  As of September 30, 2007, the accrued balances related to this program are for future severance obligations of $0.9 million and lease payments of $0.3 million that will continue into 2009 and are adequate for the estimated future requirements related to the program.

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Note 7 - Notes Payable and Capital Lease Obligations