Kaman Corp (KAMN) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kaman Corporation second-quarter 2007 earnings conference call. My name is [Grace Ann], and I will be your coordinator for today.

At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS).

I would now like to turn the presentation over to your host for today's conference, Mr. Russ Jones, Senior Vice President and Treasurer. Please proceed, sir.

Good morning, Everyone. This is Russ Jones of Kaman Corporation. I'd like to welcome you to the Company's second-quarter 2007 earnings conference call.

The conference is also being webcast over the Internet at www.Kaman.com and an online archive of this broadcast will be available within one hour of the conclusion of the call and will be available through August 10 at this site.

Conducting the call today are Paul Kuhn, Chairman, President and CEO, and Bob Garneau, Executive Vice President and Chief Financial Officer.

Before we begin, let me take a moment to reference the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. This conference call may contain certain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the Company. Although the Company believes that the expectations reflected in its forward-looking statements are reasonable, we can give no assurance that such expectations or any of these forward-looking statements will prove to be correct. Important risk factors that can cause actual results to differ materially from those reflected in the Company's forward-looking statements are included in our earnings release filed yesterday and in the Company's filings with the Securities and Exchange Commission.

In addition, the information contained in this conference call is accurate only on the date discussed. Investors should not assume that the statements made in this conference call remain operative at a later time. The Company undertakes no obligation to update any information discussed on the call.

Finally, our discussion today will include certain non-GAAP measures related to Company performance. Reconciliation of this information is provided in the exhibits to this conference call and is available through the Webcast section on our Web site.

With that, please turn to Exhibit 1, and I will turn the call over to Paul Kuhn. Paul?

Thank you, Russ. Good morning, everyone.

The second quarter was another strong period for Kaman Corporation, driven once again by the performance of our Aerospace businesses.

Yesterday, we reported second-quarter 2007 sales of $320 million, up 9.2% from the $293 million reported for the second quarter of 2006. Net earnings for the quarter were $10.1 million, up 34.4% over the $7.5 million reported a year ago. Earnings per share were $0.40 diluted, up 29% over the $0.31 diluted earned during the second quarter of last year.

Bob Garneau will review the second-quarter numbers in more detail later in the call. But first, by now, you may have had an opportunity to see that our Aerostructures, Fuzing, Helicopters and Specialty Bearings business are being dis-aggregated from the former Aerospace segment into separate segments of their own. Information has been provided in our SEC filings for the years 2004 through 2006 and for the first and second quarters of 2007.

If you turn to Exhibit 2, it provides information in a new reporting format, and I will go down through it, starting with our four Aerospace industry segments, all of which achieved increases in sales and operating income compared to the previous year's second quarter. This is certainly a reflection of the favorable market conditions being seen in the industry, but it also is the result of several years of ongoing effort that we have undertaken to realign our traditional Aerospace activities for greater efficiency and a focus on those markets where we can add the most value and grow the business.

Looking at the individual pieces, sales of our Aerostructures segment grew 36.8% and operating income grew 84.3% over the previous-year quarter. Driving this growth is the Sikorsky BLACK HAWK cockpit contract and a higher Boeing 777 ship set build rate. We delivered 18 BLACK HAWK cockpits during the quarter, compared to 11 the previous-year quarter, bringing total produced to date to 110 through the end of the quarter. Orders to date totaled 290 cockpits, and we anticipate that the program will lead to follow-on orders beyond the originally estimated 350 units. I really think this program will continue for quite a while into the future.

Along with the Sikorsky contract and our work on the 777, our production of structural wing subassemblies for the Boeing C-17 military transport remained an important and stable element of the business base. These are the segment's three largest programs. The C-17 contract had been scheduled to conclude with the completion of the 180th aircraft in mid-2007, but it has been extended for a minimum of 22 additional ship sets with deliveries through the end of 2008. Recent communications from Boeing indicate that the program could extend even beyond that.

Net sales for our Fuzing segment were up 63.7%, and operating income was up 170.6% from a low level of profitability in last year's second quarter. The sales increase was driven by increased shipments for the joint programmable Fuze program.

At this point, we believe production issues affecting JPF production have improved, enabling the increase in production achieved during the quarter. We believe the customer is pleased with our progress, and we're getting indications that the product is being actively deployed and is working very well.

During the quarter, we began production on Option 3 under the original contract. This segment has also begun to make shipments to foreign allied militaries under both the U.S. government contract in the form of FMS and on direct sales arrangements. At this point, these foreign sales are irregular and very hard to predict but they tend to be at a higher rate of profitability than those we build for the U.S. government, and they were an important factor in our second-quarter performance. To repeat what I've said in the past, this business will tend to provide some lumpy performance on a quarter-by-quarter basis, and it is better to evaluate results over a longer period.

Net sales for the Helicopters segment grew 25.1% for the quarter, while our operating loss, caused by a $2.4 million charge for the Australian program, was smaller than last year's loss, which also included the charge. In fact, the segment was close to break even for the 2007 second quarter with other programs nearly mitigating the impact of the Australian charge.

There's an extensive commentary on the Australia program in the second-quarter 10-Q filed with the SEC yesterday and in each of our quarterly annual filings over the past several years. (technical difficulty) good familiarity with the history on this program, but I will take a minute to update you on where things stand as of this date.

As previously reported, the Australian Minister of Defense had undertaken a review of the program and possible alternatives in mid 2006. In May of 2007, he announced that the Commonwealth would proceed with the Command program, subject to satisfactory contract arrangements. We are now working to find a mutual path forward to complete the program, involving payment and performance schedules, and addressing the remaining program tasks and concluding completion of the formal qualification testing of the software and acceptance of the aircraft with the integrated tactical avionic system support.

The Commonwealth has also expressed renewed interest in additional workscope involving development and testing of new software and hardware for the aircraft's automatic flight control system. That would assist the Commonwealth in meeting current Australia aircraft certification requirements. This work would have a contract value of approximately $38 million, for which the Commonwealth would be responsible. The work would take up to 29 months to complete.

Driving the sales increase at the Helicopters segment was our ongoing depot-level maintenance and upgrade program for our Egyptian SH-2G helicopters and our Sikorsky BLACK HAWK subcontract programs involving fuselage joining, installations and other work. Both of these programs are good contributors.

Moving along to our Specialty Bearings segment, the second quarter of 2007 set another sales record with a 14.4% increase over the second quarter of 2006. Operating income was 22.3% over the previous-year period.

Our products are well-regarded as leaders at the highest end of the market, and we continually find new applications for them, both to address the needs of sophisticated new aircraft and to address problems that arise with maintenance issues or service life extension programs for older aircraft. We also continue to benefit from our growing reputation as a leader in providing shorter leadtimes for product delivery compared to many of our peers.

Finally, our 35,000 square-foot new capacity is now all online and functioning. This should be sufficient to support growth for at least the next few years.

For our Industrial Distribution segment, economic conditions remained on the softer side and the segment's results for the quarter reflect that. Sales were up only 2.4% over the previous year's second quarter, which, in fact, was to a new record level. But the increase was not enough to offset the incremental increases in operating expenses and the investments we've been making to bring some new large, new national accounts online, including expenditures to bring a number of new branches onboard, four of which opened during the quarter. Operating income, as a result, was down 10.4% compared to the second quarter of last year.

The strength of markets we serve vary considerably by industry type. Industries such as food processing, mining, oil exploration, and electrical power generation continued to perform well. Certain other industries experienced a decline, including the building materials industry, which was down sharply, especially in the area of new home construction, original equipment manufacturers, and the automotive industry.

The Music segment (technical difficulty) continued slow market conditions in the quarter and sales for the segment was down 1.1% compared to the second quarter of 2006. Operating income, however, was maintained on the slightly lower sales as a result of costs cost-control measures implemented in mid 2006. The benefit realized from these measures would have been more apparent had we not incurred legal expenses associated mostly with document production in response to an inquiry by the Federal Trade Commission issued to participants throughout the music industry concerning pricing policies.

Over the past couple of months, we've seen some indication of improved customer traffic in the smaller retail stores, and this is encouraging. The large chain store customers, however, have continued somewhat weaker. Our largest customer, in fact, has been working through an ownership transition that includes some inventory reductions and that we surmise as benefactor.

Summing up, the second quarter remained on the path of progress that we've established. Our four Aerospace industry segments continued on an upward track, benefiting both from favorable industry conditions and our growing reputation as a premier quality supplier. Our Industrial Distribution segment continued to invest in new national account implementation to ramp up sales on our recent competition wins. We expect these revenues to increase in the quarters to come.

Our Music segment maintained its profitability in the slower market. We should do well here when market conditions for musical instruments sales cycle around again to the positive.

Financially, we remain well-capitalized and we have a strong business platform. Looking at the markets we are in and the work we've done to recapitalize and realign the Company, I believe we have a good reason to be pleased with our progress to-date and optimistic about our prospects going forward.

With that, I will turn the call over to Bob, who will review our financial results. Bob?

Thanks, Paul. If you return to Exhibit 3, let me start with a review of our GAAP reconciliations for the second quarters of 2007 and 2006. Starting at the top, we've entered the earnings as reported, which include earnings before income taxes of $15.6 million, net earnings of $10.1 million, and net earnings per share diluted of $0.40 in the second quarter of 2007 compared to earnings before income taxes of $12.1 million, net earnings of $7.5 million, and earnings per share diluted of $0.31 in the second quarter of 2006, an increase in net earnings per share of 29% over the year-earlier quarter.

Moving down through the columns, for the second quarter of 2007, we took a $2.4 million pretax charge adding to the loss reserve for our helicopter program with Australia. And we incurred $800,000 of deductible and nondeductible stock appreciation rights expense due to a sharp increase in the price of the Kaman shares during the quarter. Without these items, we had earnings before income taxes of $18.8 million, net earnings of $12.1 million, and net earnings per share diluted of $0.49 per share versus the $0.40 reported.

Moving over to the right-hand column, for the second quarter of 2006, we took a $2.8 million charge for the Australian program and had $800,000 of income associated with stock appreciation rights due to a reduction in the stock price during the second quarter of 2006 -- just the opposite of what we had in the second quarter of 2007. Last year, we also recovered legal fees we had incurred in the recapitalization. Without these items, we had second-quarter 2006 earnings before income taxes of $13.6 million, net earnings of $8.1 million, and net earnings per share, diluted, of $0.33 for a 2007-over-2006 second-quarter growth in net earnings per share of 48.5%.

If you would now turn to Exhibit 4, I will briefly go over segment performance. As I go over the segment operating income and operating margins on this exhibit, please bear in mind that these results are before the allocation of corporate expense back to the segments.

As you may know, the SEC has been examining corporate segment structures. During the quarter, they made inquiries of us concerning our Aerospace business' traditional structure, and a determination was made that these units should be dis-aggregated and reported as individual segments. Yesterday, we filed an amended 10-K giving this dis-aggregated data for the years 2004 through 2006, and an amended 10-Q providing dis-aggregated data for the first quarters of 2006 and 2007. Yesterday's 10-Q filing for the second quarter carried this forward to the recently completed period.

As Paul mentioned, all four of our Aerospace industry segments showed higher sales and operating income than in the second quarter a year ago. Here, for the first time, you have actual margins achieved for each of these businesses. These are all up compared to the previous-year quarter as well.

The Aerostructures segment generated sales of $23.3 million versus $17.1 million a year ago and operating income of $3.7 million versus $2 million a year ago. Operating margins were 15.8% compared to 11.7% a year ago. Increased sales and improved operational efficiencies led to the higher margins.

The Fuzing segment generated sales of $24 million versus $14.6 million a year ago and operating income of $4 million versus $1.5 million a year ago. Operating margins were 16.8% compared to 10.1% a year ago. Increased sales and efficiencies were also the cause of the higher margins for this segment, and the Company believes that its further efficiencies in foreign sales (inaudible) for the JPF program, we could see further profitability improvement. As Paul said, however, this segment will tend to deliver somewhat lumpy quarter-by-quarter comparisons.

Our Helicopters segment generated sales of $19 million compared to $15.2 million a year ago. The net operating loss was $200,000 compared to a $1.1 million operating loss a year ago. In both periods, results were adversely affected by pretax charges on the Australian program of $2.4 million in 2007 and $2.8 million in 2006. Without Australia, the segment made good financial progress as both the Egyptian maintenance and upgrade program and our subcontract work for Sikorsky on the BLACK HAWK performed well.

The Specialty Bearings segment generated sales of $31.5 million compared to $27.5 million a year ago, and operating income of $10.2 million for the quarter compared to $8.3 million a year ago. Margins for this segment were 32.4%, up from 34.3% a year ago, driven by the strong market demand for these high-performance, proprietary products.

Our Industrial Distribution segment net sales rose a small amount for the quarter to $174.6 million from $170.5 million a year ago, and operating income was $8.3 million compared to $9.3 million in last year's second quarter. The operating margin was 4.8% versus 5.4% a year ago. Topline growth here is an essential element in maintaining and increasing operating margins for this highly scalable business.

The operating environment for our customers' industries did not support good topline growth in the quarter, but a principle factor in the lower margins was the Company's investment to bring new accounts online, a worthwhile process that requires meaningful expenditures prior to the realization of meaningful associated revenues.

Music sales decreased to $47.6 million for the second quarter compared to $48.1 million a year ago, while operating income was $1.6 million and operating margins were 3.4% for both second-quarter periods. Paul mentioned the progress we made here with our cost-control measures, so this segment should perform well when market conditions improve.

On the next slide, we will take a look at our corporate expenses for the quarter. Paul has already reviewed the consolidated results. So, if you would turn now to Exhibit 5, we have a table that we also include in the earnings release that provides some insight into corporate expenses for the quarter. Elements of the expense that do not tend to fluctuate a great deal are given in the top line by both corporate expenses before break-out items -- $7 million for the second quarter of 2007, and $6.4 million for the second quarter of 2006. Portions subject to periodic fluctuations, or that are more predictable difficult to predict are presented as break-out items. You can find most these items discussed in the MD&A section of the 10-Q. Among the break-out items from the top -- stock appreciation rights expense we've talked about already. The one further point I would make is that there has been no new rights granted since 2003, and most of the old rights have been exercised. These will be decreasing in significance going forward.

Moving down through the list, pension expense shown on this table is the amount of the total pension expense of the Company retained by corporate and is influenced by factors out of our control, such as the movement of interest rates and the performance of pension plan assets invested in equity and fixed-income markets. From a cash standpoint, we expect to contribute $2.5 million to the plan for each quarter of 2007, which is approximately the same as our FASB expense per quarter.

Our supplemental retirement -- employees retirement plan is running at about the same level as last year. Group insurance follows a trend noted in the first quarter due to adverse actual claim results for the period. The second-quarter result is not as high as it was in the first quarter, but we've continued to see claims. A recovery of legal expense associated with the recapitalization was realized last year, so that's given.

Overall, our corporate expense for the second quarter was $10.1 million compared to $7.6 million for the same period last year with the stock appreciation rights and group insurance representing the major differences.

Turning finally to Exhibit 6, we have provided highlights from the balance sheet along with capital expenditures and depreciation. Notes payable and long-term debt outstanding were $108.1 million at the end of the second quarter of 2007, not a lot higher than a year ago. Shareholders equity has grown normally, principally through the growth of retained earnings. Our debt-to-capitalization ratio remains moderate at 25.3%, somewhat lower than a year ago. That provides considerable room to fund growth initiatives through our $200 million revolving credit facility.

We generally like to keep our capital expenditures in balance with our depreciation and amortization, but we have been budgeting expenditure increases of a few million on an annual basis to deal with the growth in the business.

For a final point that might be helpful, the effective tax rate for the second quarter of 2007 was 35.5%. While the adoption of FIN 48 may lead to greater volatility in the tax rate by quarter, we anticipate that the overall rate for 2007 will remain below the 39.2% effective tax rate of 2006.

That concludes the financial discussion. The Company is in good financial condition, has good access to the resources needed to move forward with our strategies, and our operating performance has continued to improve. In short, it was another good quarter for Kaman.

With that, I will turn it back to Russ. Russ?

Thanks, Bob. That wraps up our prepared remarks. We will now open the line for questions. Operator, may we have the first question, please?

(OPERATOR INSTRUCTIONS). Arnie Ursaner, CJS Securities.

Good morning. A couple of real quick questions, if I can, in Kamatics? The 35,000 square feet that you've added -- was that pretty much in place for the entire Q2, or did it kind of ramp during the course of Q2?

It kind of ramped during the course of it, but it really didn't affect our output. The capacity that we've created by it is actually future requirements.

What I'm thinking about is, to the extent you now have more capacity in place, Q3 and Q4 revenues in theory could be higher so that you since you now have more capacity to work.

We've really not been capacity-constrained. I mean, we have not turned away orders or not met delivery requirements because of capacity. We were bumping up against it, it was really tight. We knew we were going to continue to grow, so we added the additional capacity to handle it.

Shifting gears to the Australian Navy contract, obviously there was a lot of detail but I just want to clarify one thing. The write-off I think surprised some people, hoping that maybe it would be going away now that you are renegotiating. But I have a different question. You have a fair amount of cash tied up in kind of a reserve on your balance sheet. You mentioned the $38 million to reduce some elements of a contract and 29 months to complete. Will that length of time impact your ability to get the cash that has been sitting on your balance sheet back into more operating income? Or will this hold it up until that's resolved?

I guess the best way to answer that is we are going through that negotiation with the Australian Navy and the government right now. I mean, with regards to how we are going to accomplish the work that we still have to do as opposed to how much we've already accomplished, it's a very political issue in Australia right now with regards to not just us but other contractors that have not performed to their expectation but they've paid the funds to them. So we're going to have to go through this complete negotiation before we know exactly how that's going to stand. As soon as we know that, we will report it.

Perfect. Two questions for Bob -- Bob, you obviously are saying the 39% tax rate is too high. What is your guidance for a tax rate for this year?

What we said is that we will be below that, and we expect it will run 1 point or 2 below but we don't know that for sure yet.

So if I think 38%, I'm probably in the ballpark?

Yes, I think so.

Okay. Bob, in your prepared remarks, you mentioned that in the industrial distribution, you're seeing meaningful expenditures that generate meaningful revenues on this new customer. Could you attempt to quantify what meaningful expenditures were in the quarter? How would they have impacted margin? I'm assuming the four branches you opened are partially in response to that customer.

I think that, when we talk about meaningful, we spend, you know, in the a few hundreds -- you know, not something that is going to make a major difference but in the a few hundreds of thousands.

Okay. I will jump back in queue. Thank you.

Matt Duncan, Stephens Inc.

Congratulations on the very nice quarter. The first question I have relates to Fuzing. Paul, you touched on this some in your prepared comments but I'm curious how much of the strength that you experienced this quarter -- it was up 64% -- is related to maybe some of the lumpiness that you guys see in that business, versus your production capabilities picking up for the joint programmable Fuzing program. Sort of how much of that is sustainable, do you think?

That's kind of a two-part question. I think that production quantity capability is sustainable. I've talked about how we ramped up over the last couple of years. At the end of 2005, we were about 500 fuses a month; we got up to a little under 1000 at the end of 2006. We are probably in the 12, 1300 range capability, which means that we have all the people in place, the process aligned and the material flow to handle that kind of output. That will grow to over 2000 somewhere in the first quarter of next year as we fully bring along the second line up in our Connecticut facility.

The earnings are going to continually be affected by how the production quantity is distributed as to whether it's kept by the U.S. government, who has first dibs on it and they control how we actually ship the product. Inside of their contract, at higher sales or at higher pricing is the FMS side of it. Then we have the third piece, which is just a direct international sale. But again, they control how that goes out, so the more we ship to them and the more they fill their requirements, then there will be a little bit more latitude and maybe even a little bit more visibility on how those quarters are going to be.

Sure, fair enough. Back on the Australia program, just one question there -- I know you guys had talked about expecting the formal qualification testing to be finished some time around midyear this year. Can you give us an update on the timing of that?

Yes, this will become part of the negotiation. One of the difficulties we have with this customer -- and it's been going on for quite a while, and I guess it's not that different from a lot of government agencies -- is they change people frequently. We will be going down a path with a set of people and all of a sudden, everything changes and we go back to ground zero and start all over again.

We feel like we have met all of the requirements of the software to go into what they call a regression test, which is testing pieces of the software that have been affected by changes and as the software went through each phase of its test. We think that we have met everything that's required to do that, and we are ready to go into that regression test, which is a four or five-week period. We are now in negotiations with them as to whether or not they want to extend that and make it a longer test. Again, I don't have the answer to that one yet until we get through all of the discussions. We've been sending people over to Australian on a very frequent basis. It's been very frustrating for us, very political for them, very frustrating for us. But hopefully, over the next 30 to 60 days, we will get some better visibility as to how this thing is going to work out.

At the same time, we are also negotiating with them to try to get started -- try to get some funding on this second phase of the program which adds another piece of flight control hardware. That's a redundancy requirement they seem to have evolved to over a period of time in getting their aircraft certified over there. So that's the 38 million that I mentioned.

We'd like to get started on that because that really is the long pull and the [tent] to get those aircraft flying. I think that all of that negotiation is going to come together here over the next 30 days.

Okay, fair enough. Then refresh my memory. When the formal qualification testing is complete, should that coincide with a decrease in the charges you've been taking for that program?

Yes, I think, as we speak right now, charges are being reduced. I mean, they are virtually all manpower charges, and we have been reducing the headcount in the two subcontractors, Northrop and SCS. So, with those reductions in headcount comes a natural reduction in cost.

Okay. On the distribution business, you guys talked about the weakness you saw in building materials. Obviously, that's something I think everyone has been seeing, but I don't believe, in the past, you have mentioned much about how much of your distribution revenues are sort of exposed to building materials. Can you give us some commentary there?

Yes. If you look at the non-metallic material piece of that, I mean that's cement, wallboard, roofing tiles, and that's probably 5% of our sales. But you have to add into that other components that go into the housing manufacture if you want to look at the total impact of housing. That adds wood and it adds things like brass -- not brass but copper piping and all of that. We, in our estimates, feel that the total effect of the housing on our sales is about 10%.

Okay, well, I will jump back in queue. Thanks.

Steve Levenson, Stifel Nicolaus.

Thank you. Good morning. Again, sorry, but in relation to the Australian helicopter contract, between work on that contract and potential increases from Sikorsky on the H-60, have you determined about how much revenue you would have to book to offset the remaining loss accruals? Do you think this is something that will happen over the balance of 2007?

Steve, when you talk about how much we would have to book to overcome the loss accruals, I mean help me understand exactly what you're looking for there.

Well, I guess I'm asking if -- I guess there's what? $10.7 million?

Yes, that has been booked as an accrual. The cash hasn't all been spent, but the loss accrual has been taken on the books.

So I mean presumably that loss, 38 million for example, wouldn't completely offset it but with other business, you might be able to offset if you were actually required to take it?

(multiple speakers). Well, I mean we've taken the charge and we anticipate that we will need to spend that money to finish it. You know, going forward, I mean, we will see how we go as we go forward, but we would not anticipate, at this time, taking any additional loss accruals on that program.

Okay, thanks. Then recently, Boeing won an award to do some work to re-wing the A-10 attack plane. If I'm correct, I think you're involved there. Can you tell us when you think that might begin and what sort of involvement Kaman will have in that program?

Yes, this is a tough one to try to respond to. We did compete on that. We are in a quiet mode with regards to the customer. This is not irregular. Early on after an award is made by the government, the major contractor will go through a period of his final source selections and negotiations from a contractual standpoint. During that period, the subcontractors are usually not released to talk about it at all. So I guess I'll have to just defer to a later time. As soon as they are prepared to release who the subcontract partners are and all of the pieces of the award, then we will make a full comment on that but we can't comment yet.

Okay, no problem there. Thank you. In relation to the 787 and Kinetics bearings, do you think you're going to see a ramp-up there in supplying Boeing? I don't know if you're sending them sort of based on the sort of onsie-twosie production rates now and when you think you'll have to start supplying at a greater rate.

The best feel that we have right now is that it will probably deliver somewhere in the 35 to 40 aircraft in 2008 and about 75, in that area, in 2009. At that point, though, they will probably get up to either what I think has an advertised at 10-a-month rate. So --.

Have you heard anything from them about going even higher than that. We are hearing a little of that from some of the other suppliers.

No, nothing more than what you've read in the paper. I think they are getting an awful lot of pressure from their customers because they can't deliver in the time frame that the customers want. But I've lived through the prior periods where they succumbed to that pressure and made some bad decisions, raised their rates, created capacity only to have it pulled out from under them. I think they're going to be very slow to do that.

Okay, thanks. The last question -- I know it might be a little touchy, but in terms of Music and the whole business there, what's the general thoughts on strategy going forward please?

You know, earlier -- going back several years when we looked at all of our businesses, we really felt -- I felt very strongly that all of them were global through acquisitions and that would add materially to their economic value, regardless of whether we kept them to grow them further or put them up for disposal. We are still very active in the Aerospace and industrial side in our search for good, solid acquisitions. I would say that we are not doing that currently on the music side.

I've said this in the past. When I look at a priority order of our businesses as being core, certainly the Aerospace comes to the top of the heap and then industrial and music comes in third. Beyond that, all of our businesses are on the table at any specific time, so I guess that's about the only way I can answer that.

I appreciate it. Thank you very much.

Robert Kirkpatrick, Cardinal Capital.

What is the plan of record for the A-10 re-wing for Boeing, who has won this? Are you aware of what that is and can you share that with us?

Actually, I don't have that from them as yet, so again, as soon as we have that -- any information on the program regarding our participation, should that go that way, we could be obviously be very [helpful report]. But as far as the number of units and the period of time, I don't have that detail.

Okay. Could you talk a little bit about the potential market for acquisitions in the Aerospace side with the pullback in the credit markets and that hamstring-ing the private equity or the financial buyer, has that changed either the availability of potential acquisitions, or has it changed the make-up of potential bidders that you see when you were out there looking?

Yes, it's a little too early to tell. I think it takes a little longer for that to work its way through.

I will say that we are continually on the look or get a lot of paperwork here of companies that are looking to be sold. We are very selective. I think it's a good thing for us anyway and our kind of buyer to have the credit issue going the way it's going. I think will -- to make us more competitive in going after these kinds of companies.

Again, we are meeting with people. We're making trips. It is a very active part of our strategy and it has been a little bit discouraging that we haven't been able to bring any home here over the last couple of years. But I've got to say we're spending the energy to do it.

Okay. Bob, you mentioned that you had spent meaningful amounts of expenditures on the KIT side. Would you also quantify the legal expenses on the Music side as meaningful as well?

Yes, it's about the same, between probably $400,000 and $500,000, on the FTC matter.

Expensive dealing with the government! And lawyers! (LAUGHTER) No offense intended.

You've got it!

Then, are there other opportunities that you are seeing in the [rotary-ring] aircraft side of the business for subcontracting kind of beyond what you're doing for Sikorsky in two particular areas?

Yes, I think that are several primes or Tier 1s that present opportunities for a company of our capability and size. We are getting visits from them. The list would include certainly Bell; they are busting at the seams to come up with a strategy that will work better for them. We obviously think that we could participate. Spirit is also in a big move over there as they ramp-up for the new, more composite-oriented aircraft on the 787. We think that there are some opportunities that we're getting in line to compete for. So yes, I'm very bullish about our opportunities that exist in that world.

Okay. Could you perhaps address the sustainability of your various segment margins in Aerospace over the next two to three years, again assuming exogenous shocks?

Yes. Well, I think the way I've attacked this in the past is I really think that we have the capability of operating, in total, in our Aerospace group, in that upper-teens world, considering the fact that Kamatics is contributing to that level. But the other businesses, with the exception of Helicopters, certainly are a midteens-capable type of business. Helicopters, after we get through the -- it's a little too early to tell, but after we get through the Australian problems and be able -- and can deal with the kind of work that we think that we could do here for Sikorsky and also in other primes, if we can get our critical mass up a little bit, there's no reason why they can't be a contributor as well. So, I feel pretty good about where we are now and looking out the next several years.

Okay. Then, Bob, the Corporation has burned through a fair amount of working capital here in the first half. Can you help me understand what is going on in the business that is causing that to happen, and whether you expect some reversal of that in the second half of the year?

A couple of things -- if you look at the cash activity for the first six months, the earnings -- I mean, that's where cash flow comes from, essentially, is earnings. But then the working capital affects it. The two areas that affect us typically and particularly in the early part of the year are in the receivables area. One of those is with the KIT business. Typically, receivables grow from the end of the year to the middle of the year, and through the third quarter, they will probably stay up and then the fourth they tend to come down. That's typically what happens in the cycle.

Also this quarter, some of our Fuzing receivables were higher than typically you would expect. Some of that was from the JPF program. Those are there two things that I would probably comment.

Would you also have increased your inventory at KIT as you prepared for the new national accounts to come online?

There is some of that. As you can see, there was some growth in inventory during the first six months.

Great. Thank you very much, gentlemen.

(OPERATOR INSTRUCTIONS). Arnie Ursaner, CJS Securities.

A follow-up on the Music segment -- Guitar Center is your largest customer or one of your largest customers. They buy-out they had, you mentioned inventory reduction. Since you are tied in electronically to their systems, wouldn't that had been an immediate impact in Q2 on you? If so, I mean Steinway had a $10 million reduction in orders from a large customer which we assume is Guitar Center. Since, again, you are tied in directly electronically with them, can you quantify how bad your impact was in the quarter?

I don't think we had the kind of impact in the second quarter. I think, with us, it has been more gradual, and we have seen a slowdown. I don't know that -- I mean, the sales were soft -- softer with Guitar Center. That's part of what was behind our thing but I don't know that we had anything as dramatic as what you described for Steinway.

Well, again, since you replace inventory as soon as it's sold and they're telling you to reduce inventory, even if they are having pretty good sales, it would impact you pretty directly if -- as you said, if it's rolling out. Is it more of an impact in Q3 than in Q2?

No, I think my sense is -- and I don't know what it will be for Q3, but my sense is that, in Q2, it had more of an impact as they built up for this particular transaction.

Okay. Two follow-up questions for you, Paul, if you're -- on strategic, you've mentioned that a lot of primes are not -- as they question the length of the Aerospace cycle, are more willing than ever to outsource rather than build capacity. Can you comment on how you see that? You mentioned Bell for example in helicopters looking to do this. Can you perhaps expand a little on other opportunities you are seeing beyond just helicopters as primes are trying to outsource revenue and build their own capacity?

Well, I think -- I don't know how much -- I've got to be careful because I don't know how much the customers have gone out and talked about this.

I think, for example, I mentioned Spirit. Spirit is obviously moving more to the composite type of activity associated with the big parts that they're making on the 787. I really think that there are packages that are coming out of there that will be on some of the older aircraft.

You know, making metal parts, although it's not the latest in technology as far as new aircraft is concerned, is going to be around for a long, long time as these older aircraft continue to be made at some rates. I think, being here in the U.S. and having the cost structures that we do, we are just a natural fit for some of these larger players to move some of these packages to us. Those are the ones that we would be going after.

Okay. The other question for you, Paul is the CEO search process -- you've mentioned it would hopefully be wrapped up by midyear and we are kind of there. Can you update us, please?

I think I said -- I'm pretty sure I said that we would have -- our target was to have somebody on board before the fourth quarter -- be in sometime late third quarter. That, I think, is still on track. I think that we are getting close. I'm pretty confident that we will have this thing resolved over the next several weeks.

Well, you have a Board meeting coming up in August, right, after our conference? Would you hope to have a candidate on the agenda at that Board meeting?

(LAUGHTER). Yes.

Okay, that sounds like it's pretty current. I think that's it for me. Thank you.

Matt Duncan, Stephens Inc.

Just a couple of quick follow-ups here. A on the revenue potential for the new national accounts that you've picked up in the industrial distribution business, you know, I don't know if you're in a position to quantify, sort of size-wise on an annual basis, what those combines might look like. Then also, what sort of ramp should we expect in those revenues and over what time frame?

Let's see. I don't know that I want to get into that level of detail right now. I can tell you that, on the one major account, our business with that customer will go from about $10 million to $22 million or $23 million. I mean, it's a substantial increase (technical difficulty). I can say that it will probably take us the balance of this year and into maybe the first quarter of next year. I think that is a reasonable expectation to get up to that rate.

If we had been able to -- these had occurred last year, I think, between the two largest ones that we had, it would have brought enough sales to give us that 4% to 5% growth that we really need to keep our margins constant. So, they're both very, very large for us. They will be in our number one and number three accounts.

Okay, fair enough. Then, looking at Aerostructures, the sequential downtick in revenues there, I'm curious how much of that is timing. I know you guys shipped 20 ship sets in the first quarter on the cockpit for BLACK HAWK and it was 18 in the second quarter. How much of that is a timing issue and just matching of revenues to when the product is actually hitting the customer's receiving dock?

Yes, well, it's easier for me to talk in terms of rate for the quarter because we are still -- we are constrained by not only our customers' ability to ramp their line but also the other subcontractors that are providing the major components into this thing. I would say that a pretty safe bet is that somewhere in the 20 to 24 range is what we should expect to be shipping, based on their just-in-time type of requirements. But we will have the capability to get up to what we think is going to be their maximum rate, which is 10 a month, which is 30 a quarter. We should have that capability and capacity to do that very, very shortly. But we certainly can operate at the eight-a-month rate with the current manpower and tooling.

So we should expect that to tick back up then probably in the third quarter?

Yes.

Yes, the sales do -- I mean the shipments do drive the sales and the earnings there. I mean, two things affect that. One is the sales and then secondly is any estimates that we do on the profitability on the contracts, where we might have a change because we are either performing better or performing poorer. So those would be the two things that would drive the profits at that segment.

Okay. Then last question on Music -- Paul, I know you alluded to some of your smaller customers. Some of the smaller retailers are starting to feel like maybe the business is coming back just a little bit. Have you had conversations with a broad cross-section of your customer base there about what they are expecting for this Christmas season?

To be honest, anecdotally I don't have that information yet. I think it's probably just a little bit early. We will start seeing that occurring more into the later August, into the September time frame, where I think we will start getting feelings for that.

Okay, thanks, guys.

You have no questions at this time. I would now like to turn the call back over to management for closing remarks.

Well, thank you, everyone, for joining us today for today's conference call. We look forward to speaking with you again in the future. Bye.

Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.