HXL - NYSE

Hello, and welcome to the Hexcel Second quarter earnings call. [Operator Instructions]I would now like to turn the conference over to Kurt Goddard, Vice President, Investor Relations.Please go ahead.

Hello everyone. Welcome to Hexcel Corporation second quarter be recorded or rebroadcast without our express 2025 earnings conference call. Before beginning, let me cover the formalities. 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 expressed permission. Your participation on this call constitutes your consent to that request. With me today are Tom Gentile, our Chairman and 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 Hexcel's outlook continue to be very positive. Hexcel has a strong market position with a uniquely extensive range of advanced lightweight composite materials, 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 spending. 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 aircrafts per month for the 737 MAX aircraft. Solid progress also continues to the 787 build rate as Boeing moves towards producing 7 aircraft per month in 2025, following the apparent resolution of supply chain issues. For Airbus, the outlook 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 A320neo program by 2027. The A350, Hexcel's largest program is currently one of our major challenges, as 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 destocking 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 destocking to continue through the third quarter. Airbus has indicated that the destocking 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 shipset for Hexcel in the A350 is between $4.5 million and $5 million per shipset. And each monthly step-up in the monthly A350 build rate brings significant revenue and operating leverage benefits for Hexcel. The medium to longer-term outlook is very positive for Hexcel, including the expected multi-decade production life for both the A350 and the 787. The material demand requirement from these 2 programs will drive strong ongoing capacity utilization for Hexcel, which will underpin strong cash generation for years to come. As we have communicated, we expect to generate over $1 billion of cash cumulatively over the next 4 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 shipset values between $200,000 and $500,000 per shipset. The second quarter of 2025 saw strong defense sales 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 rate for most platforms. Development of new platforms is also encouraging, such as sixth- generation fighters and autonomous drones. Hexcel participated in the Paris Air Show last month, which provided a confident outlook for the aerospace industry and where we reinforce existing relationships, announced new relationships and highlighted recent advances with our innovative technology for lightweight material. Some items of note, included Embraer and Hexcel celebrated 50 years of Hexcel 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 prepregs, engineered core and advanced structures. Various Embraer aircraft platforms use these lightweight composite materials, such as the C390 military transport and the KC-390 tanker, the E2-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 Hexcel's lightweight engineered honeycomb and prepreg products for strategic production programs over 5 years. This is just one example of Hexcel's strong European presence in relation to the increase in defense spending in Europe. In addition, we announced the collaboration with FLYING WHALES and Hexcel on an exciting project to develop an advanced solution for modern air ship structures. 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 compose the skeleton of the FLYING WHALES airship. Each airship is forecast to have a shipset of more than $1 million. Looking at our financial results for Q2 2025, we generated sales of $490 million and adjusted diluted EPS of $0.50 per share. As we highlighted in our last earnings call, aircraft production rates in 2025 will not meet the initial expectations due to supply chain disruptions. 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 color. Commercial aerospace sales were up on a sequential basis. The Boeing 787, the 737 MAX and the Airbus A320neo all increased sequentially as did other commercial aerospace. The A350 sales were lower as anticipated due to channel destock. In Defense, Space and others, sales totaled $197 million, up 7.6% in constant currency in the same period in 2024. Growth was driven by the CH-53K, two international fighter programs and a strong quarter for space, including launchers, rocket motors and satellites. Adversely, 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 Hexcel lightweight materials brings to the military market. Within -- 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 A350 before the production rates continue to increase in the second half of 2025. Our gross margin of 22.8% for Q2 down from 25.3% 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 7 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 in pass-through clauses for 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 we'll 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 within 2024. This will be more than 400 heads short below our original plan for 2025. As of June 30, our head count was below fiscal year-end 2024 levels and decreased sequentially from the end of the first quarter. Our strong focus and 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 June, and the majority of our employees have departed even a small residual team to decommission the site and prepare it for sale. We took a restructuring charge of $24 million in the second quarter relating to severance and associated costs for the Belgium site. This Belgium site was operating as part of Hexcel for decades. But over time, the cost structure became untenable. While we are incurring near-term cost to close the site, there will be a longer-term reduction in structural costs within the Engineered Products segment of our business from this action. Please also note the production and sales from this plant have been transferred to other existing Hexcel sites, largely to our facility in Morocco, but also to our plant in Pottsville, 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 noncore activities, so we can focus on the upcoming production rate increases in commercial and military aerospace. Hexcel 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 team to drive growth. As build rates increase we are well positioned to drive EBITDA and free cash flow, while delivering strong returns to our shareholder [Audio Gap] publicly announced peak build rates across all their programs. Hexcel will see an additional $500 million 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 will provide synergistic benefits to Hexcel 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 Hexcel staff. And indeed, 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 or 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. Patrick?

Thank you, Tom. As a reminder, regarding foreign exchange exposure, Hexcel benefits from a strong dollar. We continue to hedge foreign exchange exposure over a 10-quarter time horizon. The year-over-year sales comparisons I will provide are in constant currency, which thereby remove the foreign exchange impact sales. 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 2024. We experienced lower sales year-over-year with each of the 4 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 demand falls. A350 sales declined year-over-year and sequentially as expected on channel destocking as Airbus faced supplier challenges causing delays in the rate ramp. As Tom mentioned, 787, A320neo 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. Defense, Space and Other represented approximately 40% of second quarter sales and totaled $196.8 million increasing 7.6% from the same period in 2024. For rotorcraft, the CH-53K and Blackhawk program year-over-year, partially offset by the sunsetting V-22 and a softer quarter for Apache. The space market grew strongly year-over-year, including both from the traditional defense prime and private-based companies. Growth was across multiple space applications, including launches, rocket motors and satellites. Gross 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 gross margin reflects the impact of our underutilized carbon fiber 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&D 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 engineered product facility in Belgium drove the other operating expense of $24.2 million in the second quarter of 2025. These costs consist primarily of severance expenses with the majority of cash outflows expected to incur -- to occur in the second half of 2025. 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 Hexcel sites. And longer term, this plant closure will help us reduce our engineered product cost structure as Belgium was a high-cost market for the product being manufactured. Adjusted operating income in the second quarter was $54.2 million or 11.1% of sales compared to $72 million or 14.4% of sales in the comparable prior year period. The year-over-year impact of exchange rates in the second quarter to operating income was favorable 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 Products segment, which is comprised of our structures and engineered core businesses, represented 20% of total sales and excluding the impact of the Belgium 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 6 months of 2025 was $5.2 million compared to net cash provided of $37.2 million in the first 6 months of 2024. Working capital was a cash use of $124.5 million in the first 6 months of 2025 compared to a cash use of $118.3 million in the first 6 months of 2024. Capital expenditures on an accrual basis were $31.8 million in the first 6 months of 2025 compared to $41.1 million in the comparable prior year period. Free cash flow in the first 6 months of 2025 was negative $46.6 million, which compares to negative $14.4 million in the first 6 months of 2024. We typically use cash in the first half of the year, and this year was no different. Adjusted EBITDA totaled $172.5 million in the first 6 months of 2025 compared to $204 million in the 2024. We used $50.5 million to repurchase stock during the second quarter, the remaining authorization under the share repurchase program as of June 30, 2025, was approximately $134 million. The Board of Directors declared a $0.17 quarterly dividend yesterday. The dividend is payable to stockholders of record as of August 8, with a payment date of August 15. 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 cash taxes will be lower than 2025 than our book taxes due to the deductibility of past R&D costs with what is in essence, a onetime catch-up. I would also like to clarify that our guidance of an effective tax rate of 21% is the underlying ETR we are currently assuming for the third and fourth quarters of 2025. Therefore, given some discrete adjustments in the first 6 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 recent tax law changes. We continue to forecast the tariff impact of $3 million to $4 million 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, so 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, fundamental outlook for Hexcel remains robust. 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 and the older generation it replaces. And as defense budgets around the world continue to get stronger, this provides an additional tailwind for Hexcel. Given this landscape, we are extremely confident that with Hexcel'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 $1 billion of cash flow in the next 4 years. Hexcel has the technology, the lightweight product portfolio, customer relationships, the qualification and the team to deliver as 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 Instructions] Your first question comes from Ken Herbert of RBC Capital Markets.

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 half for the A350 program?

Yes, Ken, sure. So as we've 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 the destocking should end in the third quarter. Airbus has said that they're going to get to 7 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 has 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, 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.

The next question comes from David Strauss of Barclays.

Following up on Ken's question there with -- Tom with destocking that you've seen in -- the destocking on the A350 you've seen in Q1 and Q2. What rate were you effectively shipping that in the first half of the year?

For the A350?

Yes.

Well, the rate -- it's always a little bit different because you -- we're a little bit ahead of everybody by 6, 8 months just because of the type of material we provide. But in the first quarter, the rates were kind of in the low 6s and then in the second quarter, in the high 5s. But don't forget, those are the rates and what they actually ship 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 6s in Q1 and kind of high 5s in Q2.

And the thing is we've got a disparity between what we're shipping in the U.S. and what we're shipping in Europe. So the destocking is likely Europe. And so we were shipping at a lower rate in Europe, whereas we're getting pulled still at a relatively high rate in a high rate in the U.S. as the [indiscernible] catches up.

Okay. Got it. So just to clarify, so those are the -- those aren't the stated Airbus rates, those are the rates you're actually shipping at.

Yes. 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.

Yes. And let me clarify, and this is the destocking aspect because what the stated Airbus rates are could be one level, but what they're pulling from us at because their destocking is another level. And so our results kind of reflect the lower number, which is the destocking. So our results won't reflect what Airbus is reporting as their ship rates because they are destocking.

Yes, perfect. That's what I was getting at. 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.

The next question comes from Gautam Khanna with TD Cowen.

Yes. I was wondering to follow up on the prior two question. Do you guys have any -- can you give us any framework for thinking how the recoupling to underlying rates on the A350 progresses in 2026? Do you think you'll be at that 7-ish rate that you implied for Q4 for much of 2026 irrespective of where Airbus is? I'm just curious like there's a destock and then as a recoupling. Just wondering the pace of recoupling, if you will.

Right. So our sense 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 7 on the A350, probably raise it to 8 sometime during the course of the year. And we'd expect that we'll be closely and more coupled with them throughout '26.

Got you. Okay. And then just on the other major programs, like say, the 787. Could 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 Boeing 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 87. Boeing has been reporting very strong production rates on that. So our pull 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? Is it -- 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?

Great. Well, as I mentioned, our average contract length is about 7 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 till 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 7 years now and about 15% or 20% come up each year for renewal.

The next question comes from Myles Walton with Wolfe Research.

Tom, you mentioned the award from Airbus for the best supplier for schedule and quality. I'm just curious 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 that key right now for commercial aerospace, 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. And 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 want to -- are working with our customers, including Airbus, to drive productivity. And so even though our contracts in the case of Airbus aren't 2 to 2030, we're constantly working productivity initiatives where we can jointly share the benefit. 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% up slope that you anticipate? Or is that something that's not really a test to the system for you?

Not an issue. We've got plenty of capacity in place, we've got a trained workforce. And that's one of the things. I mean, because the volumes 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 got enough capacity and staffing to meet the demand as they come up in Q4 '25, but also upto '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?

Yes. A large majority 85%, 90% will end up with cash. Majority of that cash, I would expect to move in the third quarter, Myles.

The next question comes from Michael Ciarmoli with Truist Securities.

Just a further clarification on the A350. Does the full year guidance contemplate low 60s? Or do you think you end up at 68. And then just from a seasonality perspective, does 3Q look a lot weaker kind of across the board than normal?

Q3 does look weaker. We've got the destocking. As Patrick mentioned, you got the seasonal holidays that always take place in Europe. So Q3 does look softer. Yes, the full year, we think, is kind of low to mid overall. But as I said, we're expecting a fairly strong Q4. Airbus is planning a rate break to 7 in September, and the destocking should really be behind us by that point. And so Q4 should be strong, and that leads into 2026.

Okay. 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 you kind of indicated, you're starting to feel it. How should we think about just the earnings guidance? 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 figure out what they are. As we said, the direct impact on us is about $3 million or $4 million a quarter. There's 3 quarters. We said we're at the low end of the range in this quarter. So we anticipate kind of given things in the outlook right now, maybe it's $10 million, 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 probably extrapolate and say it could be up to $10 million. Our EPS target is to $1.95 or $195. And so there could be some pressure that brings us towards 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 build it into the guidance and then have to change it based on what we've learned. 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 seem to us to be a little bit premature especially since it's only $3 million or $4 million a quarter, and we're at the low end of the range.

The next question comes from Richard Safran with Seaport Research Partners.

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 is spending on defense and the increases you've been mentioning in European defense spending impact your longer-term outlook. Given the increase in U.S. and Europe, I just would have to think 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?

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 strength across the board in some of our big programs like the CH-53K, where we do the whole material system or the F-35, where we provide all the carbon fiber for the material system. And then some of the space and missiles have also been strong. So we expect that to continue, if not accelerate because the underlying defense spending and the demand is so great. But we're also seeing that in Europe. 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 will 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 still 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 defense contacts in Turkey in India, and we expect those to continue to grow as well.

The next question comes from Scott Deuschle with Deutsche Bank.

Patrick, to get 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 if it is, can you walk through what's going to drive that type of operating leverage?

Yes. we clearly need to step up in the second half. We've got the seasonality sales effect in the Q3, but with cost and management, we will drive a solid 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 year as the build rates go up as the widebodies kind of move towards 7 that we spent to move 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 deliver what we see as a positive fourth quarter. So yes, I agree roughly with your numbers. As Tom said, sort of the $195 million or less the tariff impact is really where we're expecting to finish the year.

Okay. And then, Patrick, can you give the latest 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?

Yes. I mean we've never shared the details of that, but materials continues to be the largest part of our COGS followed by people cost, labor cost. I mean, energy is still single digit. I'll say that much. I think we've indicated that before, it sets 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 2, but it's in that sort of mid-single-digit level.

The next question comes from Scott Mikus of Melius Research.

Tom, to dig in a little bit on the pricing protections and the LTA negotiations. Historically, some suppliers have had to pass back productivity, the Boeing and Airbus as part of their LTAs. And you mentioned at 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 4 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 those are some of the ways that we're looking at it. The thing on productivity is that this is a tough industry, and you always need to be running fast to stand still. And our customers expect ongoing productivity. So while if we can get 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 will be in the future as well.

Yes. If 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 do we do have to elaborate.

Okay. And then thinking about build rates, we saw GE raised its commercial OE sales growth and reaffirm the LEAP delivery guidance. Boeing's production rates have been surprising to the upside. And you mentioned the A350 destocking to 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 destocking on the A350 is entirely behind you?

Well, when you say restocking, I 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 build higher levels of buffer inventory to support future higher production rates?

Yes. 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 get synchronized so that we're all at the same rates, not different parts of the chain building at different rates.

Yes. And restocking is a very gradual process, Scott. There might be a little bit of it, but it's not like destocking, which is tough and abrupt and significant restocking is very gradual over a period of time as the network as the supply chain builds up for higher rates.

But I would say, just to your point, we are starting to see this inflection point with the rates going up in a sustained way across all the main programs of Being and Airbus and so that's very positive. We're still in the kind of final throes here of the destocking on the A350, but it looks very strong for Q4, as we've said, and into 2026. And it's not just the 350, the 320, the 787, and the 737. It's been a long recovery period, but we're finally getting to the point where it's going up.

The next question comes from Sheila Kahyaoglu with Jefferies.

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 extends?

Yes. Well, I think there's 2 things going on. One is just operating leverage because if you go back to 2019, we peaked in terms of our revenue and our production. We shipped 112 A350s, and our revenue was $2.35 billion. 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 A350s. And so we're utilizing only a portion of the capacity, probably 2/3 to 3/4. And so we're not getting the operating leverage that we should get, both in terms of headcount but overall. And that's what's impacting our margin. So I think as our margins -- our revenues and build rates recover where they were in 2019, you'll see us get the operating leverage, and that will improve revenue per head count. And it will 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, up 100 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. But that's how I would lay it out.

Yes. That makes sense. And then, I guess, maybe if I could ask as the destocking 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 destocking and -- 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 shipsets in '24. Airbus only delivered 57. So it's not an exact comparison, but that's essentially what's destocking right now.

The next question comes from Gavin Parsons of UBS.

Tom, pretty healthy pace of buybacksm but I thought in the prepared remarks, you maybe sounded a little more fron-footed on M&A. I just wanted to know how you think about that trade-off and how you're contemplating size of maybe bolt-ons for something more significant.

And, 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 in 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 it can't find something that fits that criteria. We have been doing share buybacks, and we'll continue that. But that's how we think 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 selective basis.

Okay. And then it seems like Kinston is the main bottleneck on the A350. I wondered if you could share some insights on the improvement time line, given your familiarity with that facility and if you think that's contingent upon the transaction closing?

I think Airbus has pointed to that in the past, but they could probably provide more insight onto it. One thing they 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.

The next question comes from Ron Epstein of Bank of America.

This is Alex Preston on for Ron today. I was wondering, we talked a little bit about the direct impact of tariffs. Maybe if you're considering or seeing any impact indirectly on -- I'm thinking especially like robust demand in the U.S. 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 build 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. And 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 or in industrial industries with over $120 billion of net exports. And it's relied on zero tariffs, and that 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 million or $4 million a quarter. The indirect could be bigger, but we don't know what that could be yet.

The next question comes from Kristine Liwag of Morgan Stanley.

Maybe I'll kick off with a currency question. I mean, can you remind us your mismatch with your European business, how much of the European footprint are actually sold in dollars? And 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 weaker for longer, how we should expect that to result in your margins?

Yes. So we enter a year roughly 75% hedged. So if I look at 2025 for the back half of '25, we are going to be hedged more than that at this point with just those 2 quarters remaining. So we're probably 80%, 85% hedged. 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, 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 pound has actually grown a little bit, not massively, but it's grown a bit. But our hedging policy remains the same. It's very disciplined over 10 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 juncture.

Great. And if I could follow up on the contract negotiations. I mean, Tom, 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 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, the OEMs can't really change out their material input at this point, and they're pretty -- 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 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 huge investments 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. And you take into some account 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, Kristy, and I can assure you is always to maximize price and contract negotiations subject to where our counterparties will let us go.