Operator
Hello and welcome to the Hexcel second quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. And if you would like to ask a question during this time, please press star one on your telephone keypad. I would now like to turn the conference over to Kurt Goddard, Vice President, Investor Relations. Please go ahead.
Hello, everyone. Welcome to HECCEL Corporation's second quarter 2025 earnings conference call. Before beginning, let me cover the formality. I want to remind everyone about the safe harbor provisions related to any forward-looking statements we may make during the course of this call. Certain statements contained in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments, and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the company's SEC filings and earnings release. A replay of this call will be available on the Investor Relations page of our website. Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be recorded or rebroadcast without our express permission. Your participation on this call constitutes your consent to that request. With me today are Tom Gentile, our Chairman, CEO, and President, and Patrick Winterlich, our Executive Vice President and Chief Financial Officer. The purpose of the call is to review our second quarter 2025 results detailed in our news release issued yesterday. Now, let me turn the call over to Tom. Tom?
Thanks, Kurt. Hello, everyone, and thank you for joining us today as we discuss our 2025 second quarter results. The fundamentals for the commercial aerospace industry and for HEXL's outlook continue to be very positive. HEXL has a strong market position with its uniquely extensive range of advanced lightweight composite materials to meet the requirements for the record levels of new commercial aircraft on order with Airbus and Boeing as well as supporting military applications and growing global defense centers. Starting with Boeing, there is a positive momentum for their key programs with Boeing stating that they are now at a production rate of 38 aircraft per month for the 737 MAX aircraft. Style progress also continues to the 787 build rate as Boeing moves toward producing seven aircraft per month in 2025 following the apparent resolution of supply chain issues for airbus the outlet for the a320 ramp is also becoming more encouraging in terms of the growing availability of engines in the second half of 2025 to enable airbus to increase the build rate and then push monthly build rates through the 60s in 2026. airbus continues to project that they will achieve a production rate of 75 aircraft per month on the a320 neo program by 2027. The A350, Hexel's largest program, is currently one of our major challenges. It's Airbus looks to stabilize the program's build rates and move monthly rates towards 7 by the end of 2025. In addition to A350 production challenges due to supply chain disruption, we have seen some de-stocking impact in Europe in the second quarter based on high levels of inventory for A350s for certain parts, including the wings. As previously communicated, we expect this de-stocking to continue through the third quarter. Airbus has indicated that the de-stocking should end as we go into Q4, and they are still targeting to achieve a build rate of 12 aircraft per month on the A350 program by 2028. Remember that the shift set for HEXA on the A350 is between $4.5 million and $5 million per shift set, and each monthly step-up in the monthly A350 build rate bring significant revenue and operating leverage benefits for HEXL. The medium-to-longer-term outlook is very positive for HEXL, including the expected multi-decade production life for both the A350 and the 787. The material demand requirements from these two programs will drive strong, ongoing capacity utilization for HEXL, which will underpin strong cash generation for years to come. As we have communicated, we expect to generate over a billion dollars of cash cumulatively over the next four years. Demand within other commercial aerospace is also solid, and second quarter revenue saw growth both year over year and sequentially. As a reminder, the modern large cabin business jets now have extensive composite content with shift set values between $200,000 and $500,000 per shift set. The second quarter of 2025 saw strong defense sales with with broad strength across a number of domestic and international programs. Military and defense budgets around the globe continue to strengthen. Notably, NATO members in Europe have indicated that they will increase defense spending to 5% of GDP, which ultimately translates to higher and sustained build rates for most platforms. Development of new platforms is also encouraging, such as sixth-generation fighters and autonomous drones. Hexel participated in the Paris Air Show last month. We provided a confident outlook for the aerospace industry, and where we reinforced existing relationships, announced new relationships, and highlighted recent advances with our innovative technology for lightweight materials. Some items of notes included Embry Air and Hexel celebrated 50 years of Hexel supplying lightweight composite solutions by signing a preferred supplier agreement for composites. Hexcel has been a long-standing provider to Embraer on a range of advanced lightweight composite materials, including prepreg, engineered core, and advanced structures. Various Embraer aircraft platforms use these lightweight composite materials, such as the C-390 military transport and the KC-390 tanker, the E-2 jet family of narrowbody regional aircraft, and the Phenom 300 business jet. We also signed a long-term agreement with Kongsberg, the Norwegian defense and aerospace systems provider. The agreement covers the supply of Hexel's lightweight engineered honeycomb and pre-pred products for strategic production programs over five years. This is just one example of Hexel's strong European presence in relation to the increasing defense spending in Europe. In addition, we announced a collaboration with Flying Whales and Hexel on an exciting project to develop an advanced solution for modern airship structure. The project will utilize a broad range of Hexcel's products, and especially Hexcel's lightweight carbon fiber, which has been selected for the pultruded tube that composed the skeleton of the Flying Wells airship. Each airship is forecast to have a ship set of more than a million dollars. Looking at our financial results for Q2 2025, we generated sales of $490 million and adjusted diluted EPS of 50 cents per share. As we highlighted at our last earnings call, aircraft production rates in 2025 will not meet the initial expectations due to supply chain disruption. Commercial aerospace sales in the second quarter of 2025 were $293 million, down 8.9% on a constant currency basis in the same period in 2024. Lower sales year-over-year were primarily due to the A350 and the Boeing 787. However, this was partially offset by a 5.1% increase in sales within the other commercial aerospace from international demand. To share some additional colors, commercial aerospace sales were up on a sequential basis. The Boeing 787, the 737 MAX, and the Airbus A320 NEO all increased sequentially, as did other commercial aerospace. The A350 sales were lower, as anticipated, due to Channel D stockings. In defense space and other, sales totaled $197 million, up 7.6% in constant currency in the same period in 2024. Growth was driven by the TH53K, two international fighter programs, and a strong quarter for space, including launchers, rocket motors, and satellites. Conversely, the V-22 Osprey continues to weaken, as expected, as that program comes to the end of its production life. However, the overall continued growth in defense underscores capabilities and value Hextel Lightweight Materials brings to the military market. With lower-than-expected sales volume in our commercial business, we see 2025 as a year where we need to remain focused on the fundamentals of our operations and controlling costs as we navigate reductions in near-term production for commercial aerospace programs, notably the 8350 before the production rates continue to increase in the second half of 2025. our gross margin of 22.8 percent for q2 down from 25.3 percent in 2024 was negatively impacted by lower operating leverage from the lower sales combined with actions that we are taking to reduce inventory levels and then margins also were impacted by this lower overhead absorption In addition, we are now beginning to feel the impact of tariffs. However, as production rates increase in the back half of 2025 and into 2026, the increased volume will drive operating leverage and expanded margins. While production rate increases for original equipment and commercial aerospace have experienced delays in 2025, the commercial aerospace industry outlook and confidence levels appear to be getting stronger. Given this backdrop, we continue to remain extremely vigilant on the internal elements of our business that we can control, such as on-time delivery. We were pleased to receive a supplier award for best performer from Airbus this quarter, recognizing Hexcel for our outstanding delivery and quality. We continue to push pricing and recover cost inflation impacts from contracts when they renew. About 15% of our contracts by number come up for renewal each year, and historically, the average life of our contracts has been about seven years. We have worked hard over the last few years on all our contract renewals to get pricing to offset recent material, energy, and labor cost pressures, and we will continue to do so. We are also introducing more escalation and pass-through clauses to our sales contracts whenever we can. We will continue to seek price increases to offset the inflation we have countered over the last several years as our contracts come to the end of their terms. As we have mentioned in recent quarterly calls, we are managing headcount very tightly and will only add people when the demonstrated production rates clearly justify it. Specifically, as we stated in our first quarter earnings call, we expect that our headcount at the end of 2025 will be no higher than the headcount we ended with in 2024. This will be more than 400 heads short below our original plan for 2025. As of June 30th, our headcount was below fiscal year-end 2024 levels and decreased sequentially from the end of the first quarter. Our strong focus on operational excellence and general cost control remains as robust as ever as we continually work to drive efficiency and productivity. We also continue to move forward on our future factory efforts, which will see significant cost per unit improvements over the next several years, in part through the adoption of more automation digitization robotics technology and the incorporation of artificial intelligence at our production site in relation to continued efforts to optimize our production efficiency and overall facility footprint we have now completed the legal process required in belgium and have announced the closure of our engineered product facility in that country production stopped at the end of the of june and the majority of our employees have departed leaving a small residual team to decommission the site and prepare it for sale we took a restructuring charge of 24 million dollars in the second quarter relating to severance and associated costs for the belgium site this belgium site was operating as part of hex cell for decades but over time the cost structure became untenable while we are incurring near-term costs to close the site there will be a longer term reduction in structural costs within the engineered product segment of our business from this action please also note the production and sales from this plant have been transferred to other existing hex cell sites largely to our facility in morocco but also to our plant in poxville pennsylvania so there is no impact to our top line the previously announced divestiture of our australian glass fiber prepreg and recreation business is continuing and we plan to provide an update later this year we also recently divested our additive manufacturing business in hartford connecticut as part of our overall streamlining of non-core activities so we can focus on the upcoming production rate increases in commercial and military aerospace excel is well positioned on all fronts to meet the opportunities that lie ahead we have an unrivaled product portfolio of advanced lightweight composite materials we have world-leading technology and intellectual property positions we have world-class production facilities across the u.s and europe and we have the right teams to drive growth. As build rates increase, we are well positioned to drive EBITDA and free cash flow while delivering strong returns to our shareholders. OEM build rates increase and they will be a part of our growth in the next few years. Indeed, once Airbus and Boeing hit their publicly announced peak build rates across all their programs, Excel will see an additional 500 million dollars in annual revenue. That is without winning another contractor program. On top of this organic growth, we also believe there is a place for targeted and disciplined M&A. We continue to be vigilant for appropriately priced assets that would provide synergistic benefits to HEXL and complement what we do today in the sphere of advanced material science technology. To date, we have not found any actionable assets at the right prices, but we continue to look and evaluate potential opportunities. In the meantime, we have continued our periodic repurchase of HEXL stock, and indeed, we We bought back another $50 million of shares in the second quarter. This now brings our repurchases to $100 million for the year and $350 million for almost 6% of our outstanding stock in the last 18 months. With that, let me turn it over to Patrick to provide more details on the numbers. Thank you, Tom.
As a reminder, regarding foreign exchange exposure, HECCEL benefits from a strong dollar. We continue to hedge foreign exchange exposure over a 10-quarters time horizon. The year-over-year sales comparisons I will provide are in constant currency, which thereby removes the foreign exchange impact. The commercial aerospace market reported approximately 60% of total second quarter sales in 2025 of $489.9 million. Second quarter commercial aerospace sales of $293 million decreased 8.9% compared to the second quarter of 2020. We experienced lower sales year-over-year with each of the four major commercial aerospace programs including the Airbus A350 and A320 and the Boeing 787 and 737 MAX. As the overall aerospace supply chain continues to experience challenges ramping as quickly as the market demands for, A350 sales declined year-over-year and sequentially as expected on channel de-stocking as air buses face supply challenges causing delays in the rate ramp. As Tom mentioned, 787, A320 NEO and 737 MAX all increased sequentially. Sales for other commercial aerospace in the second quarter increased 5.1% year-over-year led by international demand. Defence, Space and Other represented approximately 40% for second quarter sales and totaled $196.8 million, increasing 7.6% from the same period in 2024. For Rotorcraft, the CH-53K and Blackhawk programs grew year-over-year, partially offset by the sun-setting B22, and a softer quarter for Apache. The space market grew strongly year-over-year, including both from the traditional defence prime and private space companies. Growth was across multiple space applications, including launchers, rocket motors, and satellites. Growth margin of 22.8% in the second quarter of 2025 decreased from 25.3% in the second quarter of 2024, as lower sales and inventory reduction actions negatively impacted operating leverage. Specifically, this softer growth margin reflects the impact of our underutilized carbon fibre assets and the initial impact of increased tariffs which started in the second quarter. We expect upcoming production rate increases especially in commercial aircraft to create operating leverage and drive increased margins as we go through the year. As a percentage of sales, selling, general and administrative expenses and R&T expenses were 11.7% in the second quarter of 2025 compared to 10.9% in the comparable prior year period. Upgrades to financial and manufacturing IT systems combined with some additional professional fees contributed to higher operating percentages expenses as a percentage of sales. The closure of the engineer product facility in Belgium drove the other operating expense of 24.2 million dollars in the second quarter of 2025. five these costs consist primarily of severance expenses with the majority of cash outflows expected to incur to occur in the second half of 20 let me reiterate what tom said there will be minimal impact to sales with the closing of this facility as production is transferred to other hexel sites and longer term this plant closure will help us reduce our engineered product cost as Belgium was a high cost market for the products being manufactured. Adjusted operating income in the second quarter was $64.2 million or 11.1% of sales compared to $72 million or 14.4% of sales in the comparable 5-year period. The year-over-year impact of exchange rates in the second quarter to operating income was favourable by approximately 10 basis points. Now turning to our two segments, the composite materials segment represented 80% of total second quarter sales and generated an adjusted operating margin of 14.1%. This compares to an adjusted operating margin of 17.2% in the prior year period. The engineered product segment which is comprised of our structures and engineered core businesses represented 20% of total sales and including the impact of the Belgian plant closure generated an adjusted operating margin of 10.9%. This compares to an adjusted operating margin of 14.3% in the prior year period. Net cash used by operating activities in the first six months of 2025 was $5.2 million, compared to net cash provided of $37.2 million in the first six months of 2025. Working capital was a cash use of $124.5 million in the first six months of 2025, compared to a cash use of $118.3 million in the first six months of 2025. Capital expenditures on an accrual basis was 31.8 million dollars in the first six months of 2025 compared to 41.1 million dollars in a comparable high-year period. Free cash flow in the first six months of 2025 was negative 46.6 million dollars which compared to negative 14.4 million dollars in the first six months of 2024. We technically used cash in the first half of the year and this year was no different. Adjusted EBITDA totaled $172.5 million in the first six months of 2025, compared to $204 million in 2020. We used $50.5 million to repurchase stock during the second quarter. The remaining authorisation under the Share Repurchase Program as of June 30, 2025 was approximately $134 million. The Board of Directors declared a 17 cent quarterly dividend yesterday. The dividend is payable to stockholders of records as of August 8th, with a payment date of August 15th. We are reaffirming our 2025 guidance with the caveat that we are still reviewing the recent change to tax laws. Our initial assessment is that our tax taxes will be lower in 2025 than our book taxes due to the deductibility of past R&T costs, with what is, in essence, a one-time catch-up. I would also like to clarify that our guidance of an effective tax rate for 21% is the underlying ETR we are currently assuming for the third and fourth quarters of 20%. Therefore, given some discrete adjustments in the first six months of 2025, we expect the average adjusted ETR for the full year of 2025 to be lower than 21%. And as I have just indicated, we will update our forward ETR guidance if needed once we have fully digested the impact of regions. We continue to forecast the tariff impact of three to four million dollars per quarter. However, the tariff situation remains uncertain with more potential changes to come. Our regional sourcing helps us to insulate us from the impact of tariffs, and we will continue to work on mitigations and pass-throughs, though that takes time. And finally, I would like to share a reminder of the typical third-quarter sales seasonality that arises from European summer vacations.
With that, let me turn the call back to Tom. Thanks, Patrick. Despite the challenging first half of the year and the near-term softer-than-expected demand for the A350, the fundamental outlook for HEXL remains robust. The backlog for new aircraft is at an all-time high, and every new commercial and military aircraft program brings more demand for advanced lightweight composite materials than the older generation it replaces. And as defense budgets around the world continue to get stronger, this provides an additional tailwind for HEXL. Given this landscape, we are extremely confident that with HEXL's unrivaled portfolio of technology and lightweight product offerings and given the production footprint we already have in place requiring minimal capacity increases over the next several years there is a great opportunity for Hexcel to generate strong incremental margins drive growing EBITDA and generate significant free cash flow for many years to come to repeat we expect that we will generate over a billion dollars of cash flow in the next four years Hexcel has the technology the lightweight product portfolio customer relationships the qualifications and the team to deliver at commercial production rates fully recover and defense spending increases. We appreciate your engagement with us today. With that, we're ready to take your questions.
Operator
Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. If you would like to withdraw your question, simply press star 1 again. Please ensure that your phone is not on mute when called upon. We ask that you please limit yourself to one question and one follow-up. Thank you. Your first question comes from Ken Herbert of RBC Capital Markets. Your line is open.
Yeah, good morning, Tom and Patrick.
Hey, Tom, maybe, or Patrick, just to start off, can you outline specifically what the assumption is on either build rates or delivery rates or sort of the growth in the second have for the A350 program?
Yes, Ken, sure. So as we said, that's a program that has changed. Airbus announced back in November that they were bringing down their schedule, and then in February they announced again another reduction in the schedule. So we had built our plan around 84 and we dropped that to 68 at our last call. What we're seeing now is something in the low 60s for the full year. But what we do see is that we think that these stockings should end in the third quarter. Airbus has said that they're going to get to seven aircraft per month in the September time frame, and so we're expecting a pretty strong fourth quarter, probably 2021 units in the fourth quarter of demand pull from us. And so that's how we see the year shaping out. It's lower than we originally thought, but we do see with Airbus planning to increase rates to 7 in September, that Q4 should be pretty strong as we get past the destocking.
Great. That's very helpful. And is there any reason to think that we shouldn't see continued growth within the defense space and other portfolio in the back half of the year? I think the run rate's been very nice to start the year?
It has been. It's been probably a little bit higher than we expected, and I think it should continue. I mean, as defense spending around the world on all programs is going up, so we're very encouraged with the Q2 results and extremely optimistic about the rest of the year.
Operator
The next question comes from David Strauss of Barclays. Your line is open.
Thanks. Good morning. Following up on Ken's question there, Tom, with destocking that you've seen in, you know, the destocking on the A350 you've seen in Q1, Q2, what rate were you effectively shipping at in the first half of the year?
Well, the rate, It's always a little bit different because we're a little bit ahead of everybody by six, eight months, just because of the type of material we provide. But in the first quarter, the rates were kind of in the low sixes, and then in the second quarter in the high five. But don't forget, those are the rates, and what they actually shift can be different, and it also depends on whether they can shift. Sometimes, for example, they've talked about the fact that they have some shortages on laboratories or things like that. So that can all impact it. But those are the kind of rates we saw. So low sixes in Q1 and kind of high fives in Q2.
And the thing I want to just mention is we've got a disparity between what we're shipping in the U.S. and what we're shipping in Europe. So the de-stocking is largely Europe. And so we were shipping at a lower rate in Europe, whereas we're getting pools. at a relatively high rate in the higher rates in the U.S. as the spirit plant catches up.
Okay, good. So just to clarify, so those aren't the stated Airbus rates? Those are the rates you're actually shipping at?
Yeah, what Tom was talking about is what we're shipping at, and we're shipping more in the U.S. than we are in Europe.
Yeah, and let me clarify, and this is the de-stocking aspect, because what the stated Airbus rates are could be one level, But what they're pulling from us at because they're de-stocking is another level. And so our results kind of reflect the lower number, which is the de-stocking. So our results won't reflect what Airbus is reporting as their shift rates because they are de-stocking.
Yeah, perfect. That's what I was getting at. Thank you. And then, Patrick, on currency, so you're still seeing a bit of a tailwind given your hedging. When would you expect the currency comparison to flip negative here, given the weakening in the dollar that we've seen?
We have continued to benefit, and it really does kind of speak up for the merits of the currency hedging that we do. So it was a tailwind again. I think we will actually continue to see a net tailwind this year. If rates stay where they are, we're going to see that flip or start to flip, I think, next year in 26, David.
Operator
The next question comes from Gautam Kanna with TD Cowan. Your line is open.
Yeah, thanks. Good morning, guys. I was wondering, to follow up on the prior few questions, do you guys have any – can you give us any framework for thinking how the recoupling to underlying rate on the A350 progresses in 2026. Do you think you'll be at that seven-ish rate that you implied for Q4 for much of 2026, irrespective of where Airbus is? I'm just curious, like, you know, there's a destock and then there's a recoupling. And I'm just wondering the pace of recoupling, if you will.
So our sense is, is that we'll get through the destocking in Q3. and start to get closer in terms of that coupling that you mentioned in q4 and through next year so airbus looks like they're going to enter 2026 at seven on the a350 probably raise it to eight sometime during the course of the year and we'd expect that we'll be closely more and more coupled with them throughout 26. gotcha okay and then just on the other major programs like say the 787, can you update us on where you are and how you see that progressing into 2026? Great. Well, to be honest, the first half of the year was probably a little soft for us on 787, just in terms of what they were pulling. But pulling is getting up to rate 7, and they have plans to continue all the way up to rate 10 and beyond. So again, we're expecting the back half of the year to be stronger on the H7. Boeing has been reporting very strong production rates on that. So our poll was probably a little softer in Q1 and Q2, but the production rates on that program look very strong and are expected to grow.
And last one, I think you mentioned something on the pricing side in the prepared remarks. Is there any reset that you can point to with respect to a time? Like in 2026, you start to see kind of a reset on pricing or anything you can speak to on how pricing might change and when?
Right. Well, as I mentioned, our average contract length is about seven years. So we're doing about 15 or 20% of the contract renewals every year. And when contracts come up, we always take the opportunity to reset the terms and also negotiate price to reflect some of the inflation that we've been seeing to make sure we're getting a fair return on our investment. But it's, I'd say, an ongoing gradual process, about 15 or 20% of the contracts per year. The one exception on that would be some of our Airbus contracts, our bigger Airbus contracts, including for the A350, are set up until 2030. So that's a slightly longer term. Those contracts go back, at least the A350 contract originally goes back to 2008 so that was a very long-term contract going forward we that's not been the case our contracts as i said average about seven years now um and about 15 or 20 come up each year for renewal gotcha thanks so much i appreciate it guys the next question comes from miles walton with wolf research your line is open thanks good morning tom you mentioned the um the award from airbus for the best supplier for schedule and quality i'm just curious how how do you use that to your advantage and what conditions on the ground would have to exist such that on your airbus contracts in particular because they're so onerous and so long dated where you would say we're your best supplier we're not getting value for what we're delivering and we need to renegotiate well look i think the key right now for commercial airspace for Boeing and Airbus is to get the production rates back up and to do that they need the supply chain delivering and performing and we're very proud on Airbus as i mentioned is that we received an award for best performing this was in the materials category for our quality and delivery and that's very important to support Airbus as they're increasing the rates across all their programs and so we're going to continue to do that. At the same time, we always are working with our customers, including Airbus, to drive productivity. And so even though our contracts in the case of Airbus aren't due to 2030, we're constantly working productivity initiatives where we can jointly share the benefits. So the contracts do go through 2030, but that doesn't mean we're not working productivity to drive mutual benefit in the meantime.
Okay. And just to circle the square on the A350 deliveries, so 2021 in the fourth quarter, you're shipping probably something like 10 in the third quarter. Is there any risk internally for that kind of 50% upslope that you anticipate, or is that something that's not really a test of the system for you?
Not an issue. We've got plenty of capacity in place. We got a trained workforce. And that's one of the things. I mean, because the buyings have been a little bit lower than we expected, we're essentially overstaffed. We could have probably taken out 50 or 100 people, but we didn't because we know the rates are going up in the back half and we're going to need those folks so we didn't want to have to rehire and retrain them but we are absolutely we've got enough capacity and staffing to meet the demands as they come up in q4 25 but also off through 26. okay and one last one patrick the 24 million in restructuring how much of that is cash that you have to spend in the second half yeah um a large majority of it uh 85 90 percent will end up as cash the majority of that cash i would expect to move in the third quarter thank you the next
question comes from michael charmoli with truest securities your line is open hey um good morning guys thanks for taking the question uh just just a further clarification on the a350 does does the full year guidance contemplate low 60s or do you think you end up at at 68 and then just from a seasonality perspective does 3Q look a lot weaker um kind of across the board than normal uh q3 does look weaker we've got the de-stocking as patrick mentioned you've got the seasonal holidays that always take place in europe so q3 does look look softer yes the full year we think
is kind of low to mid 60s um overall but as i said we're expecting a fairly strong q4 airbus is planning a rate break to 7 in September, and the de-stocking should really be behind us by that point. And so Q4 should be strong, and that leads into 2026.
Okay. And then just for clarification, the tariff headwind, I mean, it sounds like you're trying to offset, you've got some regional sourcing, but it kind of indicated you're starting to feel it.
How should we think about um just the earnings guidance that do we think the low end comes into play or is that range doable if you kind of get the full brunt of tariffs right well the tariffs it's they're changing frequently and so we're trying to keep up and and and figure out what what they are as we said the direct impact on us is about three or four million a quarter there's three quarters uh we said we're at the low end of the range this quarter so we anticipate kind of given things in the outlook right now it's maybe it's 10 million dollars but we don't know so we didn't include it in the guidance just because it could be smaller or larger we just don't know based on where the negotiations end up so we've left it out but you could you could probably extrapolate and say it could be up to 10 million you know our eps target is dollar 95 or 195 and and so there could be some pressure that brings us toward the lower end of the range if the full tariff impact hits but we just don't know and so we didn't want to delve it into the into the guidance and then have to change it based on what we've learned uh we'll know more in the next few months it seems like some of the deals are coming through and that will provide more clarity but put it in right now just seemed to us to be a little bit premature especially since it's only three or four million dollars a quarter and we're at the low end of the range got it helpful thanks guys thanks guys
Operator
The next question comes from Richard Safran with Seaport Research Partners. Your line is open.
Thanks. Tom, Patrick, Kurt, good morning. I just have one two-part question for you guys on defense this morning. First, Tom, you touched on this a couple of times for 2025 this morning, but could you discuss a bit more about how the administration's spending on defense and the increases you've been mentioning in European defense spending impact your longer-term outlook? You know, given the increase in U.S. and Europe, you know, I just would have to think it's infinitely better than when you started the year. And second, would you be willing to provide some comment on your view of the long-term growth and margin potential for your defense business?
Great. Well, there's no doubt that the defense spending has increased. The recent budget has a higher amount, and then there's the supplemental funds as well. So I think that is definitely driving the current performance and the outlook for the rest of the year. There's no doubt about that we're seeing it uh you know strength across the the board in some of our big programs like the ch53k where we do the whole material system or the f-35 where we provide all the carbon fiber for the material system um and then some of the the space and the missiles are have also been strong so we expect that to continue if not accelerate because the the underlying defense spending and the demand is so great but we're also seeing that in europe um you know we have a big work share on the Rafale program, which is the fighter jet from Dassault, and that was up a lot. And the demand for that is up significantly. Many countries are turning to that aircraft as they go forward. So we expect that to continue throughout the year. I don't know if it'll be the same level of increase that we saw in Q2, but we certainly expect to see strength. And as we translate that into the long term, I think that's a key aspect. Right now, defense is about 30, 35% of our total revenue. We see that as a potential big opportunity for growth organically and potentially inorganically as we go forward. So I think this long-term trend in increased defense spending, both in the U.S. and in Europe, is going to benefit our defense growth in the future. And we see that probably as our top core organic growth opportunity is defense, both in the U.S. and in Europe. But by the way, it's not just Europe. We also have some very good That depends on contacts in Turkey, in India, and we expect those to continue to grow as well.
Well, thanks very much, Tom. Appreciate the caller.
Operator
Thank you. The next question comes from Scott Duschel with Deutsche Bank. Your line is open.
Hey, good morning. Patrick, to get to the midpoint of the EPS guide, I have to assume something like a 45% incremental operating margin in the back half.
I guess, does that math sound directionally right? and then if it is can you walk through what's going to drive that type of operating leverage thank you yeah we clearly need to step up in the second half um we've got the seasonality um sales effect in the q3 but with cost and management we will drive as solid a q3 as we can and then as tom has said at least a couple of times this morning we're leaning into a strong fourth quarter as we exit the air as the build rates go up as the wide bodies kind of move towards seven um the 320 moves towards 60 and hopefully we're sort of getting aligned on the 38 on the max so that should drive pretty strong leverage as we exit the year and then deliver what we see as a positive um fourth quarter so yeah i agree roughly with your numbers as tom said sort of the 195 less the tariff impact is really where we're expecting to finish the year Okay.
And then, Patrick, can you give the latest, excuse me, split in cost of goods sold between energy, raw materials, direct labor overhead, and the like, and then has energy become a meaningfully larger share of that cost breakdown, or has that been fairly stable as a percentage of your overall cost of goods sold?
I mean, we've never shared the details of that, but materials continues to be the largest part of our COGS, followed by people costs, labor costs. I mean, energy is still single digit, I'll say that much, I think we've indicated that before. It's set up with the European impact of the Ukraine war a few years ago now, and it's still at that level. So it hasn't, certainly hasn't materially changed in the last year or two, but it's in that sort of mid, just above mid single digit level.
Operator
The next question comes from Scott Mikas of Melius Research. Your line is open.
Morning, Tom and Patrick. Tom, to dig in a little bit on the price and protections in the LTA negotiations. Historically, some suppliers have had to pass back productivity to Boeing and Airbus as part of their LTAs. And you mentioned that some of your Airbus contracts, you're sharing the productivity benefits with them. So as you renegotiate these LTAs and they come due, or you bid for new programs, are you making sure that you get to keep the productivity that you drive in your own four walls?
Well, it's a little bit of both. I mean, I would say as we get into renegotiations, we're trying to learn from the past. And so we're building in volume adjustments because certainly that was a big issue from the pandemic. We're also looking to ensure that there's appropriate escalation protection for things like inflation in labor or material or if we were just talking energy or logistics and or tariffs as we have learned so so those are some of the ways that we're looking at it the thing on productivity is that you know this is a tough industry and and you always need to be running fast to stand still and our customers expect ongoing productivity. So, well, if we can get the buying protection and we can get escalation protection, we certainly have to be willing to work jointly with them to get productivity that we share. And that's been a hallmark of our contracts with all of our big customers in the past, and I expect that we'll be in the future as well.
Yeah, because you have to remember, Scott, most of the time with all our qualified products and processes, to make changes, we need the cooperation of our customers. Now, if we can do it in-house and it's purely in-house, then yes, we would keep it. But the vast majority of the time to speed up our lines, change our parameters, we need those signed off and approved by the customer. So we do tend to work with them. And to Tom's point, ultimately, it's a competitive advantage if we can give them some benefit as well as clearly keep as much as we can for ourselves. So normally, we do have to climb.
Okay. And then thinking about build rates, We saw GE raise its commercial OE sales growth and reaffirming the LEAP delivery guidance. Boeing's production rates have been surprising to the upside. And you mentioned the A350 de-stocking could be over by the fourth quarter. Could we see a possibility maybe in early 2026 where you start to see a restocking benefit actually on the 737 and 87 while de-stocking on the A350 is entirely behind you?
Well, when you say restocking, you mean just the build rates going up?
Well, I mean, customers, some of the sub-suppliers that you ship to maybe have burned down excess inventory and need to rebuild higher levels of buffer inventory to support future higher production rates.
Oh, yeah. I mean, it remains to be seen. I think the goal for everybody is to synchronize and get everybody on the same production rates as we go forward. We're not quite there yet, but getting closer. So I don't think so. I think the goal for everybody in the supply chain is to get synchronized so that we're all at the same rates, not different parts of the chain building at different rates. Yeah, and restocking is a very gradual process, Scott.
It takes time. There might be a little bit of it, but it's not like destocking, which is tough and abrupt and significant. and restocking is very gradual over a period of time as the network has this.
But I would say, just to your point, we are starting to see this inflection point with the rates going up across all the major programs. It's been a long recovery.
Thanks for taking the questions.
Operator
The next question comes from Sheila Kealu with Jeffries. Your line is open.
Good morning, guys, and thank you. Tom Patrick, sorry, I'm going to ask you to do some math on this because all this capacity and headcount had me thinking. So when we look at your headcount per aircraft, it's actually flat versus 2019 levels. Obviously, headcount is down because revenues are down, but the actual number of aircraft people produce are the same. So it implies that you're actually getting a net price decline of 6% where other companies in the sector are probably up multiples of that. So I guess, how do we think about when that fixes itself to get the margins back up, not only based on volume, but this contract renewal process, Tom, if that makes sense?
Well, I think there's two things going on. One is just operating leverage, because if you go back to 2019, we peak in terms of our revenue and our production. We shift to 112 A350s, and our revenue was 2.35 billion and and we had all the capacity in place to support that level of production where we are now is a much different place i mean obviously last year airbus delivered 57 a350 and so we're utilizing only a portion of the capacity you have probably two-thirds to three-quarters and so we're not getting the operating leverage that we should get both in in terms of headcount, but overall, and that's what's impacting our margin. So I think as our margins for our revenues and build rates recover to where they were in 2019, you'll see us get the operating leverage and that'll improve revenue for headcount and it'll also improve margins. Now, as we've said, because we've experienced some inflation in labor and in material and in utilities, even when we get back to the previous levels of revenue, we're still going to have some headwinds, a couple hundred basis points of headwind on margin. That's what we're working to offset with our future factory initiative. And ultimately, as we get to the renewal period for our contracts is to use price to help offset some of that as well. So that's how I would lay it out.
Yeah, that makes sense. And then I guess maybe if I could ask as the de-stocking alleviates itself from the Q2 levels, what program has the most operating leverage? And then how do we think about the Belgian factory payback?
Well, I mean, the de-stocking, I mean, it's really an A350 story for us, primarily. It's our biggest program. We invested significant amounts of money from 2010 to 2019 to support the industrialization to go up to 13 aircraft per month. And the rates have been far below that, as you know, since the pandemic. And so that's the biggest issue in terms of operating leverage. And I'd say the A350 has probably been the biggest issue in terms of destocking. Just to give you some quick math, it's not perfect, but look at last year's numbers. We reported that our results for the A350, we delivered about 72 shift sets in 24. Airbus only delivered 57. So it's not an exact comparison, but that's essentially what's de-stocking right now.
Operator
Got it. Thank you so much.
Operator
The next question comes from Gavin Parsons of UBS. Your line is open.
Great. Thank you. Morning.
Tom, pretty healthy pace of buybacks, but I thought in the prepared remarks, you maybe sounded a little more front footed on M&A. Just wanted to know how you think about that tradeoff and how you're contemplating size of maybe bolt-ons for something more significant.
M&A, as I said, we're looking at it. We think it could be a good complement to the organic growth that we're going to experience, both from the recovery and build rates and the growth in defense spending. But we're going to be very disciplined. We're going to look for things that are strategic, that advance our advanced material science focus, have a heavy emphasis on aerospace and defense, and meet our return thresholds, which are quite high. But if we can't find something that fits that criteria, we have been doing share buybacks and we'll continue that. But that's how we're thinking about it is we think it could be a good complement if the right opportunity surfaces, but we're going to be very disciplined. And in the absence of that, we'll continue to fund our productivity, our innovation, our organic growth, and then continue to do share buybacks on a And then it seems like Kinston is the main bottleneck on the A350.
I wondered if you could share some insights on the improvement timeline, given your familiarity with that facility, and if you think that's contingent upon the transaction closing.
And I think Airbus has pointed to that in the past, but they could probably provide more insight onto it. One thing they've said is that once the deal closes and they take full control of that operation, they'll be able to drive more productivity, and I think that's probably the case.
Operator
The next question comes from Ron Epstein of Bank of America. Your line is open.
Hi, guys. This is Alex Preston on for Ron today. Good morning. I was wondering, we talked a little bit about the direct impact of tariffs. Maybe if you're considering or you've seen any impact indirectly on, I'm thinking especially like Airbus demand in the US and sort of maybe how you're thinking about that in the early stages here.
Well, as we've said in the past, that's our bigger concern is not the direct impact of tariffs on us, but if there's any indirect impact that could impact field rates for Airbus or Boeing. At this point, it doesn't look like that will be the case, but we need to wait and see. Obviously, there is no deal yet with the European Union, we'll have to wait and see what that is and then what the treatment is of aerospace trade that goes back and forth. One thing I'll say is, over the years, aerospace has been a great industry for the U.S. It's probably the biggest net importer for industrial industries with over $120 billion of net exports, and it's relied on zero tariffs, and that's served the industry well. So we'll see where we end up, but at this point, it's hard to say. And for us, as I said, the direct impact of tariffs is relatively minimal, $3 or $4 million a quarter. The indirect could be bigger, but we don't know what that could be.
Got it. Thanks for the help.
Operator
The next question comes from Christine Lewa of Morgan Stanley. Your line is open.
Hey, good morning, everyone. Maybe I'll kick off with a currency question. Can you remind us your mismatch with your European business, how much of the European footprint are actually sold in dollars? And, you know, also, if you could remind us regarding your hedging policy, how much are you hedged for this year and next year? And if we see the dollar be weaker for longer, how we should expect that to result in your margins?
Yeah, so we enter a year roughly 75% hedged. So if I look at 2025, for the bank half of 25, we are going to be hedged more than that at this point. With just those two courses remaining so we're probably 80 85 and head It's not 90% now through the end of 2025 We're building up our hedge profile For 2026 and by the end of this year as I said we I would expect to enter 2026 around 75% hedged We the vast majority of our sales in Europe are in dollars and with the decline of the wind energy business that was actually a source of euros that has now gone away so if anything our need to sell dollars to cover our European cost base in euros and pounds is actually grown a little bit not massively but but it's grown a bit but our hedging policy remains the same it's very disciplined over ten quarters and we layer it in each quarter as we move forward. In terms of putting a magnitude on things, yes, I mean, ultimately, if the dollar stays weaker, that will be a marginal headwind, certainly to where we are today. But I'm not going to speculate on to the size of that at this jump.
Great, thank you. And you know, if I could follow up on the contract negotiations, I mean, Tom, you know, hearing from your tone, it sounds like you're a bit more conservative or maybe more balanced regarding these contract negotiations with your customers as these contracts roll off. But when we're talking to other industry players and other suppliers, they seem to be a lot more optimistic that there's significant pricing increases for these contracts as the OEMs really want to ramp. I guess I want to understand, you know, when you're doing these contract negotiations, are there offsets that you have to factor in? Like, why can't you get more pricing through when it seems like a lot of your peers are getting that pricing. And ultimately, you know, the OEMs can't really change out their material input at this point. And, you know, you've got that strategic advantage. So why can't you get more pricing?
Well, as you go into any contract negotiation, your goal is always to maximize the value of the contract. But of course, you have to negotiate that with the other party. and so there's there's trade-offs to be made but our goal is always to make sure that we get a fair price that reflects the value we provide and the in the huge investment that we've made and also takes into account the cost increases that we've seen over the last years in labor and material and utilities and logistics so the goal is always to maximize price uh and and you take into some count other considerations. So for example, this is a long cycle business and there are only a few players in it. And the programs come up only once every few decades. And so we're always also trying to get on the next program. And the next program, of course, is going to be the narrow body and that's going to be a huge program. So that's another trade-off that you factor in. But again, our goal, Christine, I can assure you, is always to maximize price in the contract negotiations subject to where our, our, our counterparties will let us go.
Thank you Tom, and good luck.
Operator
Thanks. That is all the time we have for questions. This concludes today's conference call. We thank you for joining. You may now disconnect.
