Kaman Corp (KAMN) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Kaman Corporation earnings conference call. My name is Erica, 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 this conference. (OPERATOR INSTRUCTIONS) I will now like to turn the presentation over to your host for today's call, Mr. Eric Remington, VP, Investor Relations. Please proceed, sir.

Thank you, [Erica], and good morning, everyone. This is Eric Remington of Kaman Corporation and I would like to welcome to you the Company's 2008 second quarter conference call. This call 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 until August 8th at this site.

Conducting the call today are Neal Keating, Chairman, President and Chief Executive Officer 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 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 filings with the Securities & Exchange Commission.

In addition, 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 the Company's performance. Reconciliation of this information is provided in the exhibits to this conference call and is available through the webcast section on our website.

With that, please turn to exhibit one and I will turn the call over to Neal Keating. Neal?

Thanks, Eric, and good morning, everybody. Before discussing the specifics of our quarterly results, I wanted to provide an overview of several of the significant milestones achieved in the second quarter that will improve our competitive position in the near term and provide a foundation for continued future growth and profitability.

During the quarter we completed the acquisition of Industrial Supply Corporation, our first acquisition in industrial distributions since 2003, which provides a stronger presence in Virginia and North Carolina, expands our product offering, and brings a very experienced management team.

In addition, we opened our newest distribution center in Savannah to service our growing business in the southeast. On June 12, we acquired UK-based Brookhouse Holdings, our first acquisition in aerospace since 2002. Brookhouse brings us expanded composites capability, proprietary technology, diversifies our customer and platform base, and again a key factor in our decision to pursue Brookhouse was the proven capability of their management team. And finally we further strengthened our leadership team with the addition of Greg Steiner who joined us as President of our Aerospace Group.

Greg brings a wealth of experience in the aerospace industry and has run large global businesses for Rockwell Collins, Smith's, and most recently GE Aerospace. We are very please to do have Greg on board and look forward to his contribution. These efforts combined with our success earlier this the year in reaching a settlement with the Australian Ministry of Defense on the [Super C Spirit Program] gives us confidence we enter the second half of the year better positioned for the future. As we look at the second quarter, a quick review of results shows that our overall growth trends accelerated during the quarter.

Net sales rose 16% to $316 million driven by sales growth across our businesses. While diluted earnings per share were $0.24 versus $0.36 a year ago, the current year period includes a noncash goodwill impairment charge of $7.8 million or $0.31 per diluted share related to issues at our Wichita facility which we will discuss in more did detail. And as you'll note our second quarter 2007 results included a $2.4 million charge related to the Australian helicopter program which did not recur in the current period.

With that let's get to the reporting segments. I will start with our most challenging business currently, Aerostructures. The business demonstrated strong top line growth with sales rising about 30% over year ago levels driven by our BLACK HAWK program and continued contribution from the C17 program. Unfortunately, while we succeeded in returning the segment to profitability, generating 1.5 million of operating income excluding the impairment charge, this was still significantly below the 3.7 million of operating income in the year earlier period.

While we made progress in Wichita during the quarter including filling key operations, quality and supply chain management positions, and implementation of corrective measures to enhance operating and quality procedures, the progress was slower than either we or our customers wanted to see, and we continued to experience production inefficiencies.

Specifically, as reported earlier, the facility's AS9100 certification was suspended late in the first quarter and significant additional costs have been incurred to support inspection prior to shipment, as well as additional administrative costs required to prepare for recertification. Currently our audit is scheduled for the third quarter and we would expect to regain our AS9100 certification during the fourth quarter of this year.

In addition, we experienced additional costs in shipment delays due to the probationary status imposed by a major customer in the first quarter. This probation dramatically reduced our shipments throughout the second quarter and these delays and attending costs are reflected in our results. We did pass the customer's verification audit in mid-July, resolving the issue to their satisfaction and the customer has now allowed production to resume on all continuing programs. A concrete indication that progress is being made.

However, the compensation of these issues has affected our ability to deliver product to our customers during the second quarter and this together with issues specific to each program has resulted in the termination of our contracts with [Spirit Aerosystems], [Chien Yang] and two other smaller contracts. Currently these contracts were projected to generate total sales of about 14 million from the third quarter of 2008 through the end of 2010.

The issues we encountered during the second quarter required us to assess the goodwill associated with the acquisition of the Wichita business in 2001, and based on our analysis we felt it was necessary to record an impairment charge in the period. As I said during the first quarter conference call this performance is unacceptable. Again, we are making progress and while risks remain, we believe we will begin to see the benefits in the second half of 2008. While the Wichita situation has impact our Aerostructure segment performance, there were other very promising developments in other areas within the segment.

Overall our Jacksonville facility continues to perform very well, delivering high quality product to its customers and I am pleased to report that we were able to leverage this solid program performance into a new contract win to act as a subcontractor to Boeing to produce wing components for the A-10 program. Boeing will be delivering 242 ship sets plus spare to say the US Air Force, and we expect to ultimately ramp up to an average production rate of 47 ship sets per year.

We are under contract and already have the first PO from Boeing. Work will commence this year, but full rate production will not begin until 2011 and is expected to last through 2015. This is a significant win for Kaman that could mean over $100 million in revenue for the business over the life of the contract and will ultimately more than replace C-17 sales. However, the C-17 is not gone yet as we're under contract for 17 ship sets that will provide work through 2009.

Combined, these two programs represented a revenue opportunity for the Aerostructure's segment of over $120 million. Of course the other major development in the quarter in the Aerostructures segment was the acquisition of UK-based Brookhouse Holdings. The integration of Brookhouse into the Aerostructure segment has been progressing well, and we remain as excited by this opportunity now as we we were when we first announced it. With Brookhouse, Kaman brings on board a highly respected organization that more than triples our exposure to the fast-growing composites market.

The acquisition of Brookhouse also helps diversify our Aerostructures unit across customers, platforms and markets. Prior to the acquisition our business was very concentrated with two key customers, Boeing and Sikorsky. Clearly while these are great customer to have with strong backlogs, we wanted to broaden our customer mix.

Brookhouse added Airbus in France and the UK, Spirit AeroSystems in the UK, GKN, and BAE system to name just a few. From a platform perspective, it adds positions on new platforms such as the Airbus A-320 and A-330,340 family as well as the JSF, [Euro Fighter], Hawk, and A-400M. We're we're not at liberty to disclose the customer, Brookhouse also has meaningful content on a high volume new wide body commercial airliner program. We illustrate this on exhibit two.

These tables show the platform exposure at our existing Aerostructures business and as Brookhouse. So in summary the addition of Brookhouse nicely diversifies our customer base as well as our platform exposure. The net result is decreased revenue exposure to any one customer, as well as additional risk diversification across the commercial and military markets.

Through its aftermarket services business, Brookhouse also increases the Aerostructure's segment exposure to the aerospace military after market, and we also look forward to leveraging Brookhouse's excellent tooling capabilities to support our production programs, reducing the segment's overall operating costs and strengthening our relationships with our customers. Overall, this has been an excellent acquisition with strong growth prospects that further several of our goals in the Aerostructure segment.

Moving on, we have recently announced the renaming of our Fuzing segment as Precision Products. This is to better reflect the diversity of the segment's capabilities which includes memory products, measuring systems, and electro optics research and development in addition to fuses. In Precision Products sales for the quarter grew 13.7% to $27.2 million. Along with continued solid performance within our legacy products at Middletown, the quarter's revenue growth reflected increased JPF shipment to the US military.

However, as we have discussed, sales to the US government are at break even, and this was one of the factors leading to lower profitability in the segment for the quarter. As in the first quarter of the segment, there were limited higher margin sales to foreign military's in the second quarter as almost all of our JPF volume went to fulfill US military requirements. We also had the facilitization contract in Middletown in the second quarter of 2007.

In addition, you will recall we sold the 40-millimeter product line at the end of 2007 and profit from that line is in the 2007 numbers. The teams in Orlando and Middletown made continued progress on JPF production and I am pleased to report that we met our stated production run rate of 2,000 units per month for the quarter.

This is a significant milestone as it represents the run rate at which we believe we can fulfill our requirements under our contract to the US military while having sufficient production capacity left over to take advantage of foreign sales opportunities on a more regular basis as they arise.

Based on this performance, we hope to be in a position to fill existing foreign orders for the JPF in the second half of the year. We've discussed our goal of increasing our profitability on the JPF, and I would like to explain what we have done and what we are doing currently to achieve that improvement. While we have not yet been able to obtain all of the price increases on sales to the US Air Force, under the original contract from 1997, we have obtained foreign military sales price increases.

We have also been able to earn some additional profit on the program as we have been awarded several ancillary JPC contracts nicely profitable. An example was this was the facilitization contract in 2007 associated with our JPF production line in Middletown. Another profit initiative that we have been working is direct commercial sales, and we expect to make progress in the second half of the year.

The process of obtaining a price increase on the base USG sales beginning with option six of the original JPF contract is also proceeding well, and we are optimistic that we will get improvement beginning with option six sales, which are now expected in late 2009 or early 2010. We were very pleased with the performance of our helicopter's business where sales were slightly lower at 18.1 million compared to 19 million in the second quarter of last year.

However, overall we are seeing good progress with our depo level maintenance program for Egypt and subcontract fork for Sikorsky. The segment reported a substantial increase in profitability as there were no charges in the quarter related to the Australian Helicopter program compared to a charge of $2.4 million a year ago. At this point we are still awaiting US government approval of the transfer of the Australian aircraft before moving forward.

I would note, however, that during the quarter we retained the resources necessary to market the aircraft and secured marketing license in a number of target countries, so that we are ready to proceed once we receive governmental sign off. The settlement did have a slight impact on the segment sales in the period as service center work related to the Australian program which we generated in second quarter of last year was reduced in 2008.

I will close out the aerospace business with a discussion of its strongest performing component, specialty bearings which had another excellent quarter of growth with sales increasing over 16% to $36.7 million, and an operating margin increase of over 500 basis points from a year ago to 38%. Not only does this represent excellent growth against the year ago period, but also sequential growth from the record results reported by the segment in the first quarter of this year. Demand remains strong across the product line and the segment was able to leverage the additional sales volume into substantial increase in profitability.

We could not be more pleased with the performance of John [Kornegay] who runs this business and the entire specialty bearings team. Jack Cahill's industrial distribution team also had a great quarter that built on the progress made in the first quarter of this year. Total sales growth was 16.5% with 8.4% organic growth and the balance of 8.1% from our acquisition of ISC.

We're very pleased with this organic growth rate, particularly given the current challenging economic environment, and we are confident that we are taking share away from the smaller, less well capitalized players in the market. The growth was driven by a combination of continued strength in the less cyclical markets we serve including mining, energy, and food, as well as growth within national account programs secured over the course of the last year that have begun to gain traction.

Overall national account sales have grown almost 20% year-to-date and while we are not at liberty to disclose the name, during the quarter we secured a new national account program with a leading human therapeutics company in the biotechnology industry. Also, our national account agreement with Hormel was renewed, and we have been awarded a contract by the GSA to supply US government customers which is a significant new potential market for us.

The second quarter also marked the first period to include results from the acquisition of Industrial Supply Corp and their performance was slightly above our expectations. The integration of this business into KIT has proceeded well, and we've begun to see the benefits of this acquisition.

While KIT's performance in the second quarter was very strong, we continued to be vigilant given the uncertain economic environment. I mentioned earlier the challenges faced by this unit. These include the lower margins of ISC in the short-term, higher energy prices, margin pressure from supplier price increases, and the continued investments in new branches.

However, against this back drop we are executing on our growth strategy including our national accounts program, making the investments necessary to support it and delivering the results. As mentioned earlier, during the quarter we opened another new Greenfield branch in the Savannah distribution center, bringing our total to 12 new fa facilities since the beginning of 2007. At the same time we are also focused on tight expense management.

On this subject I should point out that while fuel costs are a concern, we are less impacted by this than you might think as the majority of our sales are not delivered by our own delivery vehicles, but rather by a third party logistics provider. Despite this, the careful management of all of our costs is a priority in this market environment to ensure that we can continue the segment's profitable growth and position it for out performance on the other side of this cycle.

Now I will let Bob Garneau walk you through the financials in more detail. Bob?

Thanks, Neal. Neal already provided some of the financial information, but I would like to add some segment detail and balance sheet and cash flow highlights. Diluted earnings per share from continuing operations for the quarter were $0.24 compared to $0.36 in the second quarter of last year.

If you turn to exhibit three, we have prepared a non-GAAP reconciliation to better compare these results. Our earnings for the 2008 second quarter include a noncash goodwill impairment charge of 7.8 million or $0.31 per share diluted related to the Wichita operation. This item is not deductible for income tax purposes. Adding the chargeback to earnings per share would result in an adjusted EPS number of $0.55 per share.

Results for the 2007 second quarter include a charge of 2.4 million or $0.06 per share diluted related to the [Australian C Spirit] program as previously announced. You will see we have added this chargeback in the non-GAAP analysis to provide a better comparison. We believe this analysis illustrates the strength of our businesses in the second quarter with the exception of Wichita and the JPF Fuzing program which lacked foreign sales in the quarter. A decline in corporate expenses was also a contributor to our results, and we'll discuss that subject later.

I should also note that we reported one penny in earnings per share for discontinued operations. This was a result of settling the closing balance sheet for the music segment which was sold on December 31 of last year. If you turn to exhibit four, let's discuss our results on a segment basis. In Aerostructures Jacksonville continued to increase sales driven by continued solid performance on the BLACK HAWK program.

Since the beginning of the year we have shipped 59 cockpits to say Sikorsky under the program compared to 38 cockpits in the first half of 2007. Regarding the new A10 program, we should begin to see revenue from this program in the first quarter of 2010. I should also point out that the helicopter segment will serve as a significant subcontractor to Aerostructures on this program which will add base in Bloomfield. Brookhouse was a part of the Aerostructure segment for about two weeks in the quarter and was profitable contributing sales of 3.6 million.

Overall, operating income for the Aerostructures segment before the goodwill impairment discharge was 1.5 million, compared to 3.7 million a year ago and reflects the impact of continuing issues at Wichita which resulted in additional 2.4 million in cost inefficiencies and adjustments during the quarter. These circumstances together with the increased carrying value of the assets at Wichita led to the write off of the entire goodwill balance in the quarter.

Helicopter sales were down slightly, primarily as a result of the reduced revenue from the Australian service center contract. The segment is performing well with no real surprises. If you add back the 2007 charge to the results, you'll see that operating profit margins actually improved on lower sales aided in part by ongoing subcontract work from MBHI and Sikorsky. The Egyptian depo level maintenance contract also provided steady state work.

As we previously indicated, Precision Product sales have increased as JPF production has ramped up. The decline in profitability quarter over quarter reflects the fact that in the current period a majority of JPF sales were to the US government and these sales are essentially break even in nature. The total cumulative value of JPF orders by the US government through the end of June was 156 million.

Specialty bearings had another outstanding quarter achieving record sales in operating profits. Operating margins rose over 500 basis points to 38% from 32.4% a year ago as the incremental sales in the period flowed through the business' existing cost structure. Despite the consistently strong growth we've seen from this segment, we believe there will remain additional opportunities for capacity expansion within our current facilities to meet demand as needed.

In the industrial distribution segment sales rose 16.5% split almost evenly between strong organic growth and the addition of ISC. You'll note as a percentage of sales the operating profit margin was consistent with the prior year at 4.8%. We expect ISC's margin to improve to the levels typically seen in our distribution business as they continue to operate as part of command and leverage our cost structure.

Branch openings also continued in the quarter in support of our national account strategy. As we discussed last quarter, our higher than average investment new branches over the last eighteen months has had a slightly negative impact on margins as it takes on average two to three years to have sales ramp up sufficiently so as to support their cost structures and provide acceptable profit margins.

If you turn to exhibit five, I would like to discuss corporate expenses. As you can see, corporate expenses were lower in the second quarter compared to the second quarter of last year, declining from 10.2 million a year ago to 6.5 million. You will note there are several items that is have contributed to the reduction in expenses including incentive compensation, a reduction in stock appreciation rights, and the serp expense. The incentive compensation and stock appreciation rights are down as a results of the lower overall earnings and the reduction in stock price. As we have previously discussed, the serp expense is being driven in 2008 by two officer retirements.

Finally, higher claims experienced in 2007 in our group insurance program have come down somewhat in 2008. The corporate expense this quarter is below our traditional spend rate. $9 to $10 million per quarter is a good estimated for what to expect for the balance of 2008. Now, if you'll turn to exhibit six, I will discuss balance sheet and capital factors. As you will notice from this exhibit, our use of cash and our debt level has gone up substantially since year end.

This is primarily a result of the cash used in the first quarter and the two acquisitions we made in the second quarter, which in total were in excess of 100 million. The debt level is still below where it was a year ago and provide us adequate capacity to operate the business and fund a certain level of acquisition activity. On the first quarter conference call, we discussed our use of cash in operations for that quarter. Operations were slightly cash flow positive in this quarter. CapEx is running a little behind our anticipated run rate for the year.

However, we expect to catch up on this in the second half of the year. In addition, we plan on acquiring the Bloomfield [Mayrot] facility during the second half of the year. Also be mindful the acquisitions of Brookhouse and ISC will result in additional amortization of intangible expenses going forward.

While we're still working to finalize our valuation of those properties we believe the additional amortization expense will likely be between $2 and $3 million per year. Overall we're in a strong financial position with flexibility to continue making strategic investments in our businesses.

That covers my remarks, and with I will turn the call back to Neal.

Thanks, Bob. As I said at the beginning of the call, while there are certainly area that is need improvement, we executed on several significant strategic objectives in the first half of 2008 that will ultimately better position command for the long-term. These accomplishments include two excellent acquisitions, the addition of Greg Steiner to lead the Aerospace group and the Australia program settlement agreement.

Overall the aerospace segments are performing well with growth at specialty bearings in particular that continues to drive the group's performance. In Aerostructures we have undertaken a number of initiatives to address the issues in Wichita and fully expect to be able to turn this business around by the end of the year. Jacksonville continues to perform well and the A-10 win and C-17 extension are excellent programs that should more than offset the business lost in Wichita. While the Brookhouse acquisition will provide the aero structure segment with new opportunities for growth.

Having hit our 2000 unit per month production target for the JPF during the quarter, we look forward to reporting additional progress on this program over the second half of the year as we continue to get closer to leveraging the significant long-term opportunity this contract represents. KIT has delivered great performance in challenging economic times, and while we will monitor the economic landscape and make the necessary adjustments to the business, we continue to believe that a focus on less cyclical markets and an effective national account strategy are the keys to continued growth going forward.

Industrial distribution has the size, capabilities, and financial strength to take market share in this environment, and this was once again proved out in the second quarter. Kaman is operating from a position of financial strength that allows to us invest not only directly in our businesses, but also to pursue strategic acquisitions that complement and enhance our current businesses.

We see additional opportunities for value enhancing acquisitions in the marketplace, and we'll continue to evaluate opportunities in both sides of our business as they arise. Overall, the first six months of 2008 were a period of significant progress for Kaman, and we believe we are on the right course for the future.

That concludes our formal remarks, and with that I will turn the call back to Eric.

Thank you, Neal. That wraps up our prepared remarks. Now we'll open up the line for questions. Operator, may we have the first question, please?

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Arnie Ursaner from CJS Securities. Please proceed.

Take a stab at it. It is Arnie Ursaner of CJS Securities, but good morning.

We knew that, Arnie.

Many questions obviously a raise from your release and extensive conversations, so I guess I will start with first and foremost on Wichita.

Obviously the language in the Q about things like withdrawn from, suspended and all of these terms and the termination of two contracts. I guess the broad question I have is, is there a plan you believe you have underway that can restore the facility to profitability? Do you have enough opportunities or volume to cover your fixed costs in any reasonable timeframe?

Good question, Arnie. Where we stand right now, Arnie, I think there is a couple of key things we need to focus on. Number one, you're right about some of the language relating to suspended and withdrawn, et cetera, but here it is.

I think, number one, the Wichita facility is very important to us, and that is why we are putting the effort in to make sure that we can can get that business up to the same level of performance that we have in our Jacksonville facility today, and I am confident that we will be able to achieve that although it will take the balance of the year for us to work through the current issues that we have.

I think the most important things to focus on are that, number one, we did have a probationary status imposed by a major customer. We were able to successfully work through that issue, and as we said in our comments, we were given the authorization to go forward on all of their current programs in mid-July of this year. I think that is a critical concrete indication of the progress that we've made.

We've gone through our [Ned Cap] certifications for multiple processes within the facility and received [Ned Cap] certification for those processes. We're scheduled for our AS9100 recertification audit in August of this year. We have everybody focused on securing our recertification. We believe it will take a couple months after the audit to get that. So, it would probably occur in the fourth quarter of this year.

In addition, if we look at the business through the facility, there is a couple things for to us keep in mind. Number one, the issues -- the business is about 55 to 60% military, Arnie, and we have continued to serve our customers primarily Boeing, IDS, through this period, and so we have not had an issue with that part of the business.

In addition, if we looked at the fourth quarter, the programs that have been canceled or terminated, [Chien Yang], the [Spirit flight deck floor] and the two other smaller programs made up approximately 10% of the volume out of that facility. So I believe that we have the volume in the facility to return it to profitability.

We will have to do some resizing there, but we will do that, and I believe that that facility is important to us in the long-term because of the capability and cost structure that it delivers to the business.

2.4 million of cost inefficiencies you incurred this quarter. Are you expecting levels similar to that for the balance of the year by quarter?

We expect, Arnie, that that will come down. It will probably be unprofitable out there for the next two quarters, but at a lower level on the premise we don't have any other issues flare up.

Bob, if I can ask one of you if you wouldn't mind focusing on exhibit five, perhaps you could try to help all of us. So you mentioned in your prepared remarks you expect to see corporate expenses move back to the nice to $10 million per quarter level for the balance of '08.

We have some pretty well defined language about the serp impact in Q3, but I guess what I am trying to ask you to do if you wouldn't mind is take the base level before breakout items of 5.8 million you incurred and walk us back to how you get to the nine to ten. What are the key elements we should look for in that if you don't mind?

You have to give him just a second, Arnie.

By the way, Neal, how is your back?

It is a lot better. I have been a little busy, no boating lately, to hurt my back.

If it helps you, the language you had on serp in your Q is five million in the quarter, but the balance expected in August. I am trying to again equate the five million with the .9 you showed and the balance in August. Struggling to understand how they equate.

I think that I don't have all of that detail in front of me, but and you do know the third quarter you explained with the serp payment. It is going to restore, I mean, before breakout items are going to tend to trend a little bit higher, be a little higher, but again our estimate is that they will come back to a level, and I just don't have all of that detail in front of me.

Not a problem. We can follow up later. Look forward to seeing you guys at our conference and thanks again. Good quarter.

Thank you.

The next question comes from the line of Matt Duncan with Stephens Inc. Please proceed.

Hey, guys, this is [Jack Atkins] on the call for Matt. Congratulations on the nice quarter.

Thank you, Jack.

Just a couple quick questions here. First of all, turning to the charge and its impact on EPS. If we back out the charge and assuming a normal tax rate and then assuming a normal level of incentive comp, because you have a benefit from that in the quarter.

Yes.

We were coming up with around $0.52. Does that sound accurate to you guys or not?

Just do again on the corporate rate.

Right. I mean, okay, I think you said that the charge was kind of for $0.31, right?

Correct. $0.31, and it is the -- if you look on that non-GAAP analysis, you can see that it just drops right through without any tax benefit.

Right, right, and then but also backing out the benefit you received from the lower level of incentive comp, because of the charge. Do you think it is fair to back that out as well and if so, so, kind of what --

That would get tax affected at a normal 35, 36% rate.

Okay. Okay. So you would think $0.55 rather than backing out any further benefit from incentive?

So, you're right. If you took the 7.8 out, the incentive, you would lose some of the benefit of incentive comp. It would probably revert back to a -- you would probably add back a good piece of that that we took out in the quarter.

Okay. Okay. Thanks a lot for that, and then looking at the two lost contracts at the Wichita facility, just a question as far as the remaining base of business there.

What is the remaining base of business and dollar amount if you can disclose that and then how do you utilize the extra capacity there going forward that was created by the extra -- by these two contract losses?

Jack, initially as we said, we don't disclose the size of that business. It is a -- it is not a very -- it is not that big of facility, Jack, I will just leave it at that. Again, I would come back to what we said earlier, and that is that the contracts that we have lost made up about 10% of the revenue out of that facility in the fourth quarter of last year.

We're using fourth quarter because it was about the average for shipments for the year. So there is not at this point all that much additional capacity that we would need to fill up. In addition, Jack, it is an area where we believe that we have the opportunity to grow and get incremental business into the facility once we've restored our certifications. So I am not overly concerned about our ability to fill up back to -- to replace that 10%. Obviously as we would go out to 2011, 2012, 2013, with the ramp up at that point of the 787, it would have been more meaningful to us.

Okay. Great. Just a couple other items here. Your sales at your Precision Products segment, they were up nicely in the quarter. I am just curious about how we should think about sales for the JPF to the US government going forward, should shows sales kind of plateau and level off or should they peak and go back down?

We expect still some increase, and the reason is that they've been very successful at increasing the production rates. And while we've hit actually in the second quarter we hit our target for the year, we still expect that we'll be filling USG backlog with that although our hopes and our work with the US government is to be able to divert some of that to direct commercial and foreign military sales. But we would expect to see that continue to ramp up for a little bit, and that the preponderance that far would still go to the US government.

Great. One last thing. If we look at the strong organic growth in your industrial distribution segment, it was really nice in the quarter. What end markets were the strongest and the weakest?

Jack Cahill will appreciate you asking the question as they get a little pressed during the com. Actually, Jack, the markets that continued to be strongest for us are mining. Mining is doing extremely well year after year, excuse me, year-over-year. Energy as you would expect for us is doing very well, and then driver really by the strength of our success with national accounts that tend to be less in the less cyclical food, beverage, tobacco markets, that has really helped us tremendously.

The areas that we continue to be down on or down in are housing, and frankly as we said before, Jack, housing now is a very small part of our business so it has a somewhat muted impact. And we are a supplier to a smaller degree to the automotive industry predominantly to the people that are the tier-1s or tier-2 suppliers, and we're down there, but again it is a very small relatively small part of our business. So frankly the businesses that were up in the first quarter for us continue to be up, and a little bit of continued growth in our national accounts.

Okay. And just finally based on the discussions that you've had with your customers, what do you expect to see growth wise for that segment going forward, and I will jump back in the queue? Thanks.

Jack, we're going to have tougher comps for the industrial distribution business in the third and fourth quarter. I am working off the top of my head a little bit, but I think in the third quarter of last year our growth was between 6% and 7%, and I know in the fourth quarter it was just a little bit above 10%.

So we're headed into two comparative quarters where the comps will be more difficult. Obviously with the acquisition of ISC we'll have about 8% growth there through acquisition as was common demonstrated in the second quarter. We certainly I think in the last call people asked us if we thought we would be in the 5% to 6% organic growth range, and we certainly would like to target that.

Okay. Great. Thanks a lot.

Our next question comes from the line of Steve Levenson with Stifel Nicolaus. Please proceed.

Thanks. Good morning, Neal, Rob and Eric.

Good morning.

Hi, Steve.

Looks like Brookhouse is something that's going to prove to be really important. Can you tell us is there autoclave capacity totally spoken for or do they have room to book more business?

Do you have any orders to give us?

Yes, but I don't build any planes, so it is not going to help a lot.

A lot of people are getting in the business. They have capacity that is available for additional business. They have some programs that will be ramping up. They have a very some really good business development people there, so we're hoping for some good things out of that business, but right now they are not capital or capacity constrained.

Okay. Thanks. Can you tell us about the significance of their capabilities in out of autoclave processing?

I can tell you a couple things, and we certainly hope to be able to tell you more in the not too distant future, but what they have developed is a resin film infusion technology. Other people have done it as well. However, they have been able to demonstrate it to major commercial OEMs, gained very good acceptance with it.

It enables enables them to do more complex shapes in closed molds with an oven curing process rather than an autoclave, so it is lower cost. And again enables you to make some more complex shapes than you can otherwise do. So it was a technology that really interested us in our acquisition analysis.

It was something that I was familiar with from a prior life, and clearly is one where a number of OEMs are really looking to that technology to enable them to get lower weight on new aircraft, and that was one of the key reasons we bought them.

Sounds great. Now, you mentioned lower weight on new aircraft. I know some of the manufacturers Airbus particular talking about trying to remove weight from existing designs that they wouldn't have to recertify. Do you see retrofit opportunities for non-primary structures on existing models?

Yes, we do, and you named Airbus obviously would like to do that on their high volume A-320 family, and we would love to be successful in working with them to achieve those goals.

Thanks. On the specialty bearings side, is some of the sales growth coming from A-380 buyers taking the dry wing option or is it just across the board?

I can't answer that question specifically. I know that our A-380 business is up from year to year.

Our expectation is that has been driven by them beginning to ramp up although slower than they would like, but to ramp up their production and some of the people using up the inventory they had from prior year shipments. But I can't comment about the dry wing option.

Do you see on the A-350, I don't know if you're talking to them or if you can say anything about if it is going to be an option there or standard item or not at all?

We are currently working with Airbus across our Aerostructures and specialty bearings business. I cannot comment that we've gotten any contracts or orders for them for any options on that aircraft yet.

Okay. Thanks. Last question. Where are the [Australian C Sprits] and what's going on with them? Have you had any interest?

The -- we are still working with both the US and Australian government to finalize the paperwork for the title transfers so that we can take possession of the aircraft, but we have already engaged with a number of countries in discussions. We've applied for and been granted marketing licenses for a number of countries, so we're not waiting for the transfer of the aircraft.

We're out and actively marketing them. We're at Farm Bureau and follow-up meetings after that, so we're active. We don't have possession of the aircraft yet, but in the end again as we talked about in the last quarter, we think it is meaningful that the first guaranteed payments the Australian comment wealth are three years from now.

Got it. Thanks very much.

Thank you.

Next question comes from the line of Edward Marshall with Sidoti & Company. Please proceed.

Good morning, everyone.

Good morning.

Hi, Ed.

My first question is may have been addressed in the last conference call, but can you quantify the extra costs associated with the suspension of the certification that's with the Wichita branch?

What we said was in the second quarter that we had 2.4 million in inefficiencies, and adjustments, and a lot of that inefficiency came from the fact that shipments were very hard to get out the door, and they needed additional inspection and quality sign off, and I mean it is hard to be specific beyond that.

So the 2.4 million includes the third party certification and so forth?

Yes, all of that is in that.

And the audit that's coming up, I guess it is in the third quarter here. Are we to anticipate any costs hitting the line here with the audit?

I think that, yes, we have costs involved in preparation for the audit, and we will have some costs for the audit as well. And if any minor deficiencies or for that matter any major deficiencies are identified during the audit, we will have ongoing costs to correct those.

Okay. I am assuming we consider those one-time in nature, but is there anyway we can qualify what that might be?

It is hard. We again -- I will say that we certainly anticipate that the losses that we would experience out there would be less which would be qualifying -- quantifying those into it in the third quarter versus the second quarter. It is tough to go beyond that.

We can wait for the next quarter. Jack, this one is for you, I guess. As you walk through the -- as you work through the acquisition integration of ISC, at Industrial Distribution, Can we talk about the possibility of margin potential expansion in the industrial segment? Is that possible?

Jack isn't with us.

No, no, I meant it was kind of you said that he would be excited that we got --

Thank you. I will tell you, I will give you a -- as you would expect, we analyzed our second quarter results, and we're very pleased with the acquisition of ISC. As we said, it is actually delivering slightly above our expectations.

If we were to remove the ISC sales, cost of sales, et cetera, we would have been approximately 20 basis points higher in our base business. So we would have had approximately a 5% return on our base business.

Okay. Can we assume that you can get to somewhere where the competitors are though on the operating line, maybe 10% of what Granger kind of gets?

I think a better comparison actually would be AIT which is I believe around 7% to 7.2%. That is certainly our target. We have a ways to go to get there, and we have to get there through additional growth both from organic growth as well as inquisitive active growth to get the scale we need to take better advantage on the sell side.

And also some of the inherent deficiencies that you get of putting that incremental sales through a fixed cost base, and quite honestly as well we've been very successful with our national accounts, but we've had to make investments as we've said to support those.

We need to get further up the maturity curve of our national account program so that we're actually on the plus side of the economics there rather than the investment side. So it is going to take us awhile, but there is nothing systemic our business that would prevented us from making progress to toward that 7% that AIT has.

Okay. On the Aerostructure side, the Sikorsky business with the 32 ship sets this year, my original assumption was it would ultimately get to 36. Am I first right in that assumption, 12 a month I think it was said, 36 per quarter?

I think that's a little bit high. I think we said nine to 11 per quarter.

Okay. That said, with the new contract win I guess with Sikorsky or the increased amount of ship sets over the period of time. Is there any anticipation that we could accelerated that and actually see additional ship sets per month above that nine to 11?

I don't think we would be prepared to comment on that right now.

Okay.

That's our target for and we stated that's our target for the year, so I I am not prepared to do go beyond that right now.

Fair enough. And the specialty bearings, is there a backlog number that you're prepared to give or is that just a yearly number?

Actually based on the questions in the call last quarter, we actually integrated it into 10-Q this year.

I will look it up. That's fine.

Okay. That's fine.

Fair enough. Thanks, guys.

Sure. Thank you.

Our next question comes from the line of Robert Kirkpatrick with Cardinal Capital. Please proceed.

Good morning and kudos to you for disclosure in the 10-Q. It is very comprehensive, and the outside investors appreciate that.

Thank you.

Neal, could you provide us with perhaps an update as to where things stand on the search for a new CFO? I understand Bob is going to be retiring in the next year or so.

You had to bring that up?

You didn't want me to answer that, Rob.

Well, I don't care. Do you want Bob to answer it? How about Jack?

( laughter ). Okay. Well, Rob, we've actually initiated the search. We've selected the executive recruiting firm that we're going to use, and we've begun that process. Bob's current retirement target March of next year.

Our goal is clearly to have someone on board with sufficient overlap prior to Bob's scheduled departure. He is also said that he is flexible in that if we want a little bit more overlap, and the good news is that he is going to be close by.

Great. Thank you so much. A couple of questions regarding the A-10 contract in Jacksonville. If the A-10 contract ramps as it is currently scheduled, and the C-17 business does not go away. How full will that facility be in terms of utilization in the out years?

Actually, Rob, it is a good question and one that we've been looking at right now. If we keep the C-17, that facility would be very full. We have identified another building that has actually walking distance from the existing one that if it is apparent that there would be a ramp up of the A-10 concurrent with the C-17 continuing that we could add.

We've worked with the landlord. As a matter of fact, it is the existing landlord for one of our buildings in Jacksonville now. It is also one, Rob, where as you know that's an assembly business so there is not a lot of fixed capital equipment that we put in there. It is jigs and fixtures and other things like that, so there is not a big capital investment in doing that. It is really lease costs.

Okay.

We're prepared and frankly I don't think it would surprise anybody that we would love to see the C-17 continue.

Okay. And then on the Kamatics business can you take that and roughly break that business down in three ways. One, between commercial and military, two, between OEMs and aftermarket and, three, between fixed and rotary wing?

How about if we try two of the three questions?

I will take two of three.

Okay. If we were to look at '07, Rob, it is roughly 75/25 commercial versus military, so 75% commercial, 25% military. The second question was how much of that was --

If you broke it down between OEM and aftermarket.

Okay.

Or if you broke it down between fixed and rotary wing.

We can do the after market one. Aftermarket, if you bear with me one second, we're actually prepared for that question, and I believe it is 60% forward fit, 40% aftermarket.

Okay. And then on --

They probably do have a split rotary wing versus fixed wing, but that's a little bit more difficult because some of the business goes through distribution, Rob.

Okay. And then on the KIT side, realizing you can't tell us too much about your new national account with a major pharmaceutical company. Can you perhaps try to ballpark quantify it? Would this be one of your top two, three accounts? And also could you comment on the potential magnitude of the GSA contract that you won during the quarter as well?

It is a significant -- I have never used the word therapeutics before.

( laughter ).

But that well known biotechnology firm, it is going to be a significant account for us. It will be meaningful. We're very happy to win that. We will probably as we progress and ramp that up, Rob, it will be something that we'll be able to give a clearer indication, and I don't mean to be to duck that question, but it is a new account.

We have an expectation for it, but we obviously have a ramp-up period to get there, but it is going to be a meaningful account for us. We're very happy to get it. The second question.

On the GSA contract, Rob that, essentially gives us the ability-- we're in the GSA catalog, and enables us now to participate in that purchasing channel from the US government, but it is not a contract for a fixed amount. That market we believe is about $600 million, but we are very new at that, so it is a very important opportunity for us going forward, but that's going to take a few years to really start to mature.

And the 600 million is just the part of the overall government need that would deal with your products, correct?

That's correct. They have what they call a hardware super store category, and we estimated that at about 600 million, so that is the subsegment we would participate in.

Okay. And I note that the new that the therapeutics company has locations in Puerto Rico. Is that an area of potential expansion for KIT or do you have a presence there?

That is a potential for future expansion. We do not currently have a presence there.

Okay. Finally one for Bob. Bob, can you quantify how much excess working capital has been used in the first half of this year that perhaps is a little extraordinary and might flow back in the back half of this year and then 2009?

Let me see if I have a piece of paper that I can --

Rob, I really appreciate you directing that question to Bob.

I think traditionally what happens is during the first quarter and to some extent the second quarter, we tend to see increases in our accounts receivable. And usually the end of the year they're down, so I think that there is some certainly there is some ability there to recapture some of the as the year goes on and particularly in the fourth quarter. And I think we've got some more in inventories and we've got capacity there to recover money.

Those if you look at the three areas where we had significant usages in particularly the first quarter but now cumulatively through the second. Our receivables and inventories and then down below you see this sum in income taxes payable, and of course that was some money that we paid for the Music transaction in the first quarter. So I think what I would like to would be the receivables and the inventory and in terms of amounts I am not sure I have a specific amount, but I would think that we would get recovery on those as the year goes on.

Now, these numbers are going to get twisted around a little bit once the Australian settlement happens because that will affect the working capital numbers, too, as the year goes on and we take in the inventory and some of the inventory numbers will change and be substituted with receivables and vice versa.

And the cash effect of that FH2 taking in, you're going to take in inventory, but you'll have this liability side will offset it?

Yes, the asset side of that is going to be pretty much an exchange of accounts. The liability that will make a difference is when we have to make the income tax payment which I think we indicated was in the neighborhood of 13 million to recapture the profit, the losses contract that we had. So that will be the cash impact and then of course as we sell them that will all get more than offset.

And so, you'll make the $13 million payment when you take title to the aircraft?

Yes.

Great. Thank you so much. Congratulations again.

Thank you, Rob.

Our next question comes from the line of [Jonathan Morocco with Venadium]. Please proceed.

Hi, guys. Good afternoon. Can you discuss whether there is anything unusual going on regarding bearing inventory in terms of destocking? I know it would seem odd given the sales growth and backlog within the segment, but I heard that some distributors are indeed destocking.

We haven't seen that, Jonathan, and I haven't had that reflected through our team in specialty bearings, so it might be a different segment of the market where they're doing that.

Got it. All right. Thanks a lot, guys.

Thank you, Jonathan.

Our next question comes from the line of Jerome Lande of Millbrook Capital. Please proceed.

Good morning. The drag from in distro new account build up and the integration costs, I think you quantified earlier in terms of what the margin would have been, but can you give the actual dollar number you can contribute to in the quarter?

That dollar number, actually, Jerome what, we talked about was the difference between the base business which would include our national accounts business and the impact of the acquisition of ISC where that was a lower margin business that we acquired and also we go through an inventory adjustment in the first period that we own them. We said that was a 20 basis points impact from 4.8% to roughly 5%, but we did not -- that was not related to the specifics on our new branch openings.

Can I have that number, the new branch openings and integration costs, not necessarily the -- I understand what you're saying, not the differential in margin based on the two businesses but rather whatever unusual items might have been flowing through?

Actually the way that we've historically talked about that, and I think what we're prepared to talk about right now is that we've opened some 12 locations over the -- since 2007. It typically takes two to three years for those to turn profitable. So we would expect that all of those twelve are currently still at below our 4.8 to 5% return, and we also said that typically is costs us $200,000 to $300,000 to open a new branch, but that's the level of disclosure we've gone to right now for competitive purposes.

Okay. Switching gears to the JPF for a second. So it looks like I guess the Air Force went out for request with credentials or something like that and I don't know if they got anything back.

They may not have and maybe that's not a surprise given that it is not a very profitable contract or profitable at all at the moment. But I am just wondering on a longer term basis in terms of how you're going to allocate capital here, you're up to the run rate of what you think more or less the military will be demanding.

There may actually be more, you have to get foreign sales to be profitable on it. And the whole thing is probably going to be recompete in 2010. Long-term is this a business that this Company is going to be in? Can you not recompete on the US but still sell to foreign governments? What are the sort of long-term options you have to make this more of a productive allocation of capital?

Good question. I think there is a couple of things to keep in mind. Number one, that the US government has paid for facilitizing our facilities in both Orlando and Middletown, Connecticut. So those have been elements of the program where the US government pays for the facilitization as opposed to us having to invest our capital.

However, from a working capital perspective, you are right. What we tried to take people through both in the comments in the Q which may be a little bit difficult it follow is that what we have been able to do, I mean clearly, Jerome, we need to get this more profitable.

The key for us in doing that is two fold. One, to be able to sell a higher percentage of product to both foreign military's both through FMS and DCS sales because those are nicely profitable for us today. But because we have not been able to meet the demand for the US government which of course has First Call on the product, we have not been able to divert and improve the sales mix to include DCF and SMS sales.

Short term that's what we have to do, and we've taken the first big step in getting to the 6,000 unit per quarter production rate that we had actually targeted for the fourth quarter, so that's important to us. The second is that we're going to recompete the contract on option six.

What we talked about was shipments on that contract would begin in late 2009, early 2010 dependent solely upon when we're able to finish the requirements for production on option five. So the recompete for that contract will be prior to 2010 and will give clear visibility as to the profitability going forward on that contract.

So have you had discussions then with the Air Force about what the pricing expectations should be on that recompete and what has their reaction been?

We have had those discussions discussions. We have very good reliability of the product in the field, that they're extremely pleased with. The quality is higher, it provides another number of advantages them which are critical such as captive carry which allows them to leave it on the wing longer. So they're very pleased with aspects of the program.

They granted us a price increase for foreign military sales which actually goes through the FMS branch of the US government, so there is recognition there as well. But as with anybody, customers want to make sure they get the best value for money, so it will be a negotiation with us.

But we feel since we're the sole provider for that product today since when they made the determination to add a second source, they elected to have command be the second source making the product in Middletown in our Middletown facility, rather than going onto a competitor was an important step as well. And frankly a barrier to entry to anybody else trying to recompete or to compete against us on the option six.

Okay. Thanks. Switching gears again, there has been no shortage of air time or ink spilled about oil price impact on new builds and the aftermarket and so on and comparing it to 9/11 or what have you. Obviously everybody has their view.

I am wondering do you want to add your view as to what the Company's plans are, what you've modeled in at different oil prices as far as the feedback you're getting from OEMs and so on and just generally what your views are with where we are today in the commodity markets?

Sure. As you said, everybody has given their view of that, and I think that people -- that we all have our own opinions. I worry about our business. So I break it down into two elements. Number one, if we look at aftermarket to begin with, for those aircraft that are going to be parked, for example. People talk a lot about the 737 classic, the MD80.

The only part of our aerospace group that has any significant commercial aftermarket exposure is our specialty bearings business, and as we said that's about 40% of their business. However, they did not have much content on those aircraft types, so it is not impacting us very much.

In fact, we've gone out in preparation for this call and assessed it, and we believe that we will not have an impact from the parked aircraft or lower capacity for our specialty bearings business for the balance of this year and as we look at next year, we expect that the impact would be less than $5 million.

It could be two, it could be five. So, frankly, we see a fairly muted impact in the only business where we have an aftermarket component with the exception of our Brookhouse acquisition and that's really UK military. So we don't expect it to impact them.

Okay. Thanks a lot. Congratulations on the good quarter. Thanks a lot, Jerome.

(OPERATOR INSTRUCTIONS) Our next question is from the line of Matt Duncan with Stephens, Inc.

Hi, this is Jack again. A couple quick follow-up items. First of all, what do you anticipate the impact will be on 2008 and 2009 earnings from Brookhouse?

We haven't disclosed that, Jack.

Yes. I think what we said is there will be marginal in '08 and start to be accretive in 2009.

I am sorry, from an accretion perspective. I understand. I thought from individual profitability.

Okay. Great. Finally, what should quarterly interest expense be going forward since you used that to fund the Brookhouse acquisition?

I think if you look at what's in there for the quarter, you can sort of see that and then based on the disclosures we've made for the acquisition, you can get a pretty good sense of what the expense would run. But we would expect that it would run again -- looking at the debt levels and looking at the current rates, you can pretty much get a sense of what the interest would be.

Can you remind us again what the interest rate is on your debt?

It's 5% roughly.

Okay.

LIBOR plus two, something like that.

Okay. Great. Thanks a lot, guys.

There are no further questions. I would now like to turn the call back over to management for closing remarks.

Okay Thanks for joining us for today's conference call. We look forward to speaking with you again when we report third quarter results. Goodbye.

Thank you for your participation in today's conference. This concludes the presentation. Everyone have a great day.