Kaman Corp (KAMN) 2009 Q3 法說會逐字稿

Good day ladies and gentlemen and welcome to the third quarter 2009 Kaman Corporation earnings conference call. At this time, all participants are in a listen-only mode. (Operator Instructions)

I would now like to turn the presentation over to Mr. Eric Remington, Vice President, Investor Relations. Please proceed.

Thank you and good morning everyone. I'd like to welcome you to the Kaman Corporation 2009 third quarter conference call, to discuss our earnings results and outlook for the remainder of the year. Conducting the call today are Neal Keating, Chairman, President and Chief Executive Officer, and Bill Denninger, Senior Vice President and Chief Financial Officer.

Before we begin this morning, be advised this call may contain forward-looking statements such as projections of the revenue, earnings, and other financial items, statements on the plans and objectives of the Company or its management, statements of future economic performance and assumptions underlying these statements regarding the Company and its business. The Company's actual results could differ materially from any forward-looking statements made due to several important factors described in the Company's filings with the Securities and Exchange Commission.

With that I will turn the call over to Neal Keating. Neal?

Thanks Eric. And good morning.

Our third quarter performance reflected another period of solid fundamentals. We were able to report slightly better than expected top line results in aerospace and margin improve in industrial distribution despite the challenging operating environment. Combined with the continued progress we have made in reducing cost this allowed us to improve our cash flow generation and overall financial position. We also had a number of significant accomplishments during the quarter which will help position our Company for the growth over the near and longer term and I will discuss each of those accomplishments as I review our two segments starting with aerospace.

The Aerospace segment reported a slight year-over-year decline in revenue as higher BLACK HAWK cockpit and JPF Fuze deliveries were offset by lower bearing volumes across commercial, business jet, and regional jet markets. We continue to feel the impact of weakness in the commercial aerospace market. Passenger traffic remains down, and new orders for air transport class aircraft have declined. As have regional and business jet production rates. Although regional and business aircraft bearings has historically represented about 15% of our aerospace bearing revenues, the sharp declines we are seeing in that business had the most significant impact on our results. While sales of bearings for air transport class aircraft were not down as sharply.

Given the stability of military spending, our military bearing sales were relatively flat compared to the prior year. The importance of the diversity of our business base becomes even more apparent during these difficult times as growth in our Sikorsky BLACK HAWK and JPF Fuze programs was able to offset a substantial portion of the declines in commercial, regional and business jet bearing revenues. We delivered 38 cockpits to Sikorsky in the third quarter, including our 400th cockpit delivery. This compares with 31 units in the same period last year, but down from 43 in the second quarter of 2009.

In our JPF program, we started delivering option 5 during the second quarter with our overall JPF US government and foreign military sales increasing 33% over the prior year. We have delivered over 22,000 JPF Fuzes through September, compared to just under 17,000 in the same period last year. As we previously announced, we were awarded a contract modification on JPF options 6, 7, and 8, which provides for higher pricing on the JPF US government production units beginning with option 6 and will substantially improve the profitability of the JPF program. Additionally, during the quarter we received notification that the US government is increasing our award for option 6, from $53 million, to $59 million. We still anticipate that option 6 deliveries will begin in the second quarter of 2010.

Another important accomplishment announced in September was the award of a five year, $53 million contract with Bell Helicopters to bill composite helicopter blade skins and skin core assemblies. This is significant for Kaman as Bell is a sizeable customer for us on the bearing side but has not previously done business with us in helicopters or aerostructures. We expect initial deliveries to Bell will begin later this year.

We also announced in September that we received a contract on behalf of team K-MAX which is our joint effort with Lockheed Martin to demonstrate the ability of the unmanned K-MAX helicopter to the US Marine Corps. This helicopter is an unmanned version of our K-MAX helicopter that is designed to deliver cargo in extreme environments and at high altitudes. We are scheduled to demo the aircraft in December, and if successful, we could potentially do an in-theater deployment next year. It is important to note that other companies could potentially participate in this program as well. However we feel confident in our product and technology and while the potential revenue from this project would start out slowly, the unmanned K-MAX helicopter could be an important source of growth for our Company over the longer term.

Finally, during the quarter we were awarded a blade erosion coating contract from American Eurocopter. This expands our blade erosion coating efforts to four military platforms -- the BLACK HAWK, Apache, CH-53, and now the Lakota. These accomplishments are all indicative of the quality of our products and excellent customer service within our aerospace businesses. As evidence, during the quarter our Jacksonville aerostructures facility received Sikorsky's Top 100 Supplier Award and we were also awarded UTC Supplier Gold at our Bloomfield specialty bearing's facility for a second consecutive year.

Moving to industrial distribution, we saw signs of stabilization in revenues during the third quarter and were able to improve our operating margin. This was despite the ongoing challenging conditions in many of our end markets -- machinery, mining, fabricated metals and nonmetallic minerals all continued to be soft during the quarter but this was partially offset by higher volumes in food and paper end markets. Overall our daily sales rate improved each month during the third quarter with September daily sales hitting the highest level we have experienced since November of 2008. We also continued to expand our product line to enable us to grow our relationships with existing customers and convert new accounts as we strive to increase our market share.

As I've said, the gross margin initiatives that we have executed this year at KIT allowed us to maintain our gross margins on a year to date basis despite lower rebates, and this helped us to increase our operating margin on a sequential basis from the second quarter. We were pleased to have achieved this improvement even with the nonrecurrence of one time cost savings such as furloughs that occurred during the second quarter. We remain focused on improving our operating profit conversion rate on each dollar of sales, even in a declining revenue environment.

This week we also announced the appointment of Steve Smidler to the newly created role of Chief Operating Officer at KIT. Steve brings 28 years of experience in the industrial automation market, a keen understanding of our customer and supplier base and a global mindset, having worked in Europe earlier in his career at Rockwell Automation. We are confident Steve will play a key role as we grow our KIT business.

In summary, while continued weakness in the commercial aerospace market and many of our distribution end markets leaves us with limited visibility into the timing and shape of recovery in these businesses, we expect to continue to benefit from our diversification, our leading position in several product categories and our sound capital structure. We will continue to operate our business with a view towards maximizing our near and long-term growth, including continuing to manage our costs aggressively and taking advantage of opportunities to expand our business and gain market share.

Now I will turn it over to Bill Denninger to walk you through the financials in more detail. Bill?

Thank you Neal and good morning.

Third quarter sales were $290 million, down 13.5% compared to the third quarter of 2008, and down 1.1% compared to the with the second quarter of '09. The year-over-year decrease was driven by a 20.2% decline at KIT and a 3% decline in our aerospace segment. Foreign currency translation negatively impacted our total third quarter sales by $4.2 million or 1.4%. Net earnings were $9.6 million or $0.37 per diluted share, down 29% compared to earnings per share of $0.53 in the prior year, and equal to the second quarter. On a segment basis for the quarter industrial distribution sales were $163 million, down 20.2% year-over-year but up 4.5% sequentially.

Organic sales declined 20.4% year-over-year, partially offset by sales from the [Enrumack] acquisition we completed in 2008, which added $2.6 million or 1.6% to sales during the quarter. Compared to the second quarter of 2009, organic sales increased 2.7%. Segment operating income was $3.4 million, down 68% compared to the prior year, but up 10.5% sequentially as result of higher sales volume, stable gross margin and the cost reduction initiatives we have implemented. As a result operating margin improved by approximately 10 basis points compared to the second quarter. We've taken several actions to reduce our cost structure, since the downturn began and the majority of our cost savings have come from payroll, pay reductions and unfortunately head count reductions. We were able to show sequential improvement in our third quarter operating margins even without the use of furloughs in Q3 compared to Q2. We continue to make headway on our ability to better convert each dollar of sales to the bottom line and work towards our operating margin objective of 7%.

Moving to the aerospace segment, sales in the quarter declined 3% year-over-year and 7.5% sequentially to $127 million. Sales were slightly better than we had forecasted due to higher than expected helicopter subcontract, and blade erosion coating program revenue. Segment operating income $19.9 million, down 4.6% compared to the prior year and down 7.8% sequentially. As a result, operating margin for aerospace was 15.7%, flat with the second quarter but down approximately 20 basis points compared to the prior year as improved profit margins on our JPF program were offset by a mix shift away from our higher margin bearing product lines. Because our bearing product lines carry higher gross margins than the rest of our aerospace programs any sales decline has an out sized impact on our operating profit dollars and overall aerospace margin. We do believe that the cost reduction actions we've taken will allow us to maintain our higher operating margins in the bearings business on slightly lower volume.

Moving on our consolidated results were impacted by pension expense of $3.9 million, which was $2.2 million higher compared to the third quarter of last year, and $6.6 million higher for the 9 month period. For the full year, we expect pension expense to be approximately $16 million or $9 million above the prior year as previously disclosed. Our effective tax rate for the third quarter was 24.7% compared to 33.8% in the first half of the year. The lower tax rate in the quarter was a result of a nonrecurring tax benefit resulting from a foreign exchange loss incurred as part of an international recapitalization. The effect of the lower tax rate in Q3 contributed $0.05 to earnings per share. We expect our full year effective tax rate to be between 30% and 32%.

Our cash flow was again solid as we generated over $22 million in free cash flow during the quarter. Through the first nine months of 2009, we have generated $40 million of free cash flow compared a use of $48.5 million during the same period last year. Our balance sheet position remains strong. During the third quarter we finalized our new credit facility, which both extended our debt maturities by three years, and increased the size of the facility from $200 million, to $225 million. We were well over subscribed for the deal, increased our number of lenders from seven to 13, and enhanced our financial flexibility to be able to take advantage of any attractive growth opportunities as they arise. In summary our overall financial position remains strong with a low amount of leverage and no significant near-term maturities.

I would like to now discuss our outlook for the remarried of the year. In industrial distribution, our visibility into the timing and magnitude of recovery remains limited. In the near-term, we continue to project our full year sales decline for 2009 to be at the high end of our previously stated range of down 10% to 15% from the prior year. We are concerned that fourth quarter sales could be even weaker than projected however based on October actual sales levels which came in slightly below expectations. From a margin standpoint we continue to anticipate that our full year operating margin for this business will be approximately 200 to 250 basis points below last year's 4.6%, assuming fourth quarter sales do not deteriorate further. This does take into account our previously stated expectation to deliver annualized cost savings of approximately $12 million by the end of the year of which about $2.5 million is nonrecurring.

In aerospace we continue to expect revenue for the full year to increase 5% to 7% over 2008. As we communicated last quarter we expect fourth quarter revenues to be stronger than the third quarter, although given the better than expected performance of aerospace in the third quarter we expect sales to be up only slightly. We continue to expect full year aerospace operating margins to be in the mid teens but anticipate that our fourth quarter margins may weaken slightly compared to the third quarter due to mix of business within our helicopter product lines.

In summary we delivered another solid quarter of earnings in the challenging operating environment. While we will remain focused from streamlining our cost structure, our diversification and strong financial position allow us to continue to prudently invest on opportunities to grow our business. With that I will turn the call back over to Neal. Neal?

Thanks, Bill. Before we take questions I would like to add a few closing comments.

While we are facing challenges in certain parts of our aerospace business our diversification in this segment exposes us to a multitude of growth opportunities which we are exploring every day and it would help us to mitigate weakness in any particular business. We have also won several important contracts during the quarter which will provide us with additional opportunities to further diversity and grow our business. In industrial distribution, we are encouraged to see the business stabilizing and even showing some signs of sequential improvement. While we cannot predict when or what the shape of a full recovery will be, through cost reduction and other operating changes, we are improving our ability to convert each dollar of sales to profit.

We have some of the best products and people within the industries that we serve, as evidenced by the Sikorsky and UTC awards we received this quarter. We believe we have adopted the right strategy to navigate through this downturn while keeping an eye towards the future to ensure we best position Kaman for long-term growth. We have also continued to strengthen our management team with the addition of Steve Smidler and we are confident he will help the Kaman Industrial Technologies business reach its full potential. That concludes our formal comments, and with that I will turn the call back to Eric.

Thanks Neal. Operator, may we have the first question, please.

(Operator Instructions) Your first question comes from the line of Arnold Ursaner with CJS Securities. Please proceed with your question.

Good morning. I'd like to focus my questions on the industrial distribution piece if I can. Obviously you had a lot of quarterly variability in revenue trends. Can you give us a feel for your best sense of your client inventories, and the types of orders you are getting. e you seeing more frequent but smaller orders, perhaps explain why September was so much better and the falloff in October -- was there some timing issue. Any additional color or feel you can give us for what your customers and you are seeing in the distribution area. Also remind us if you can how many days you have in Q4 versus Q3. I know that affects revenues sometimes.

Okay. We will start maybe from the back and work forward. We had 64 business days in the third quarter. We will have 60 in the fourth quarter, and I believe that we had 64 in the fourth quarter of last year so that will give you a little bit of the daily sales rate. Because you are exactly right, that does impact us obviously.

I would take a step back Arnie and say from a -- beginning from an industry perspective, of our top ten industries only three were up. We had increases in our food market, our paper market, and our beverage market. But everything else whether it was mining, fabricated metals, chemicals those were all down. I can't say that we had any particular impact other than industry type Arnie in terms of size of orders. We have begun as we commented in the last quarterly call -- we have begun to see some capital projects being bid and probably had a few move through in the third quarter, but we have not seen a dramatic shift in our sales to larger project related orders as we did have in 2008 for example primarily for the metals industry, copper mining, et cetera.

The -- we do have a normal seasonality where third quarter is a little bit stronger. We had 14.5% growth if you remember in the third quarter of 2008 -- about half and half acquisition and organic -- and typically our fourth quarter is weaker simply because of the holidays and also I just believe that we have planned shutdowns. Normally that's down about 4% to 5%. This year because of the uptick in [ISM] and other things we are positioning ourselves to be able to take advantage of a slightly stronger than normal fourth quarter if it occurs, but we are also cautious that we may have customers that would decide to have extended shutdowns in the fourth quarter if their business levels don't sustain or tick up. So that's why we are trying to be both positioned to take advantage of volume in the fourth quarter that occurs. But we are also cautious because we just don't know if customers will go to extended shutdowns as a number did last year.

That's a fair response. The other question I have is -- you've invested quite a bit in facilities along the way and typically the pattern is you incur expense year one, achieve break even in year two and start to see some meaningful incremental margin in Q3 -- year three. Can you freshen up where we stand now in that process.

I don't think that that would -- that that normal process would change, however when you consider that across the board in all of our regions, all of our branches that volumes are down, I would expect that if we look at facilities that are in their second or third year, I wouldn't doubt that we are probably a year behind that normal progression.

Thank you, I will jump back in queue, thank you.

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

Good morning, guys. I want to get back to KIT for a minute. You guys talked about a lot of the sequential uptick you saw there in revenues happened in September. Sounds like it's back off again in October. What do you think probably was responsible for that and what customer group drove that uptick in September.

Matt, it's a good question, one that we've had our October numbers for all of a few days. We don't have that analyzed to the degree that we would like yet. It was not any one region that was down quarter to quarter. It was not -- or excuse me -- from the third quarter to -- from September to October -- we do have a normal -- within a quarter we normally have our strongest daily sales in the third month of the quarter. I honestly can't tell you why that is, we can go back historically, that's the trend. It declined somewhat in the first month of the following quarter.

We are down slightly from September to October. We had hoped that we would stay flat, so I can't say that there is anything -- we are talking a couple of percent from the normal seasonality or 2% from the normal seasonality. So I really don't know that there is any one thing that would stand out to us.

That's helpful. Then if you look at the competitive environment there, what are you seeing in terms of pricing pressure in the marketplace? Are you starting to see some of that out there?

Well, I think what is important, Matt, is that we operate in the same environment as all of our competitors do. We have been able to maintain stable gross margins from year to year despite as you would expect significantly lower rebates. So as we look at our quote unquote pure margin -- our selling margin, we are actually marginally up from year to year. As we outlined back in prior calls Matt, our goal is to get 7%. We thought there were a number of components we had to focus on to enable us to get there. A lot of them have to do with scale to get rebates and pricing from our suppliers.

Scale to be able to amortize our set fixed costs better, product mix certainly, but also, we were very candid that we felt we had opportunities to improve our pricing discipline. Jack Cahill and his team have worked very hard through the end of last year and throughout this year to improve that pricing discipline and I think the ability to sustain our gross margins in this environment given lower rebates is a credit to their team and the hard working they've done.

I would definitely agree with that. When you look at what the economic data points are doing as it pertains to that business. Typically distribution companies are going to lag the economic indicators a quarter or two. Are you seeing any of the normal signs you would be seeing right now if that would be the case in this cycle? Are you your customers getting more positive in their tone? What are you hearing I guess, what do you think about what the lag may look like versus the economic indicators this time.

Normally we have lagged the ISM by three to six months. We now are at three months, from the first uptick in ISM, and other than what we talked about in the September, October dynamic, we haven't seen a big tick up. We seen anecdotally a number of larger project programs are beginning to be quoted. Again, perhaps in part because of some of the return to better commodity pricing. But our food, beverage, paper industries remain strong. We haven't seen an uptick yet in OEM of any note. Low dollar might help us there. But it's going to take companies going out and beginning to spend on capital equipment.

I can't say that we have seen anything other than the increased quoting for project jobs that would lead us to believe that there may be some upside here. But we remain very cautious, we are trying to get our cost structure to the point where we can leverage any upside volume. We want to make sure we have inventories in a position to respond to that. We've sustained very high fill rates but we want to have inventory so we can take advantage of any uptick in volume. But I can't tell you right now that there is anything that leads us to believe that there is something imminent.

We've puzzled on it ourselves right now with ISM being up three months in a row. We'd like to see it come through to our business. But as we sit here today, other than the September and October dynamic we haven't seen it.

Last couple of things and I will get back in queue. I just want to turn to aerospace for a minute. Do you have any cost control measures that you employed this quarter to help hold the operating margin there flat despite the down revenue sequentially.

We did have a couple, Matt, we've gone through some adjustments in the cost structure of our specialty bearings business. We've had reduction in force there. Predominantly in the hourly and some of the indirect work force. As we commented earlier in the year, we've increased our engineering resources there. We've sustained those resources, we took advantage of a couple furlough -- a couple day furloughs in there. But that was primarily it in the specialty bearings business. Outside of that there were not actions taken across the balance of the business.

Last thing when you look at the new agreement you have with Bell what do you think the revenue ramp should look like there.

It's a pretty quick ramp. We expect to begin delivering some product in the fourth quarter of this year. Obviously we will have some start up costs associated with that, we will be early on learning curve so we don't expect it to contribute to profit. But we should probably be at about a $4 million to $5 million run rate for 2010. Which is about the annualized run rate that we would expect there and certainly we will continue to work hard to expand that business relationship now that we established it with the helicopters and aerostructures businesses.

That's $4 million to $5 million annually in revenue?

That's correct Matt.

Okay, thanks Neal, appreciate it.

Your next question comes from the line of Edward Marshall with Sidoti & Company. Please proceed with your question.

Good morning, guys thanks for taking my call. On the aerospace side of the business did we receive any benefit or is there improvement that you can discuss in Wichita.

Well we got a slight improvement from Wichita from quarter to quarter.

Is there anything that we can quantify, did it break even?

No it did not. We were able to -- we've had a ramp where we have been reducing the loss every quarter we continued on that ramp. We are still in a loss making situation there and as we said -- it didn't get worse, it got better, if it got worse we would tell you, if it had gotten a lot better we would tell you that too. We really -- as we said, need to get about $4 million to $5 million of additional volume in there to have it break even. We don't have that business in there yet but they are continuing to execute on their plan of reducing the losses that they have given the current run rate they are at.

Assuming everything is constant in the business -- and I know there are some give and takes -- but that could lead us to believe there could be sequential pick ups down the road from a margin perspective in that business -- the aerospace business as a whole.

That's fair, yes.

I just needed clarification -- you said the high end of the range-- I think you meant the low end of the range. Just my interpretation of it for the industrial distribution guidance. It should be closer to negative 15, not negative 10.

That's correct. You can look at that up or down or high or low, but we mean 15.

Then I wanted to focus on the balance sheet for a couple of seconds, you gave us your outlook on your cash, but how are you going to put that cash to work. I know we mentioned acquisitions in the past. Can you give us update as to what the acquisition front looks like.

Initially as we generate the cash, we are paying down debt we will continue to do that, but hopefully we will be able to get a deal or two done in 2010. We think the valuation GAAP that we've seen all year, this year should contract at least in 2010 and would love to spend some of that money in our borrowing capacity and perhaps stock for the right deal or deals.

Has -- what side of the business -- I know we talked about both, I know you made some good acquisitions on the industrial side. Is it fair to assume that both sides are fair game, but does one look more likely right now.

We have a full pipeline on both sides of the business. From a management perspective we are agnostic -- we like both businesses so it's what is out there and which comes first.

Thank you, guys very much.

Your next question comes from Steve Levenson with Stifel Nicolaus. Please proceed with your question.

Thanks, good morning, Neal, Bill and Eric.

Hi, Steve.

Want to combine a couple of the questions and answers you just gave. On Bell is that work being done down in Jacksonville, in Connecticut or in Wichita?

It's being done in Connecticut right now.

You think -- Sorry go ahead.

Two places in Connecticut -- our specialty bearings business of course, and our helicopter blade sales right now. Our goal obviously is to now that we have been able to expand that relationship with Bell is to demonstrate the value that we can add as an outsource partner to them as we have with Sikorsky and continue to grow that business.

Thanks. It sounds like Bell's parent, which also owns Cessna has its hands full with facilities but do you think they will be doing more outsourcing and do you think you can get into the other side as well.

I will tell you Steve, the issues that the business aircraft primes are facing today are tremendous given reductions in production rates of if you're a Hawk or Beechcraft or a Cessna of 35% to 50%, I think it's going to cause them to revisit a lot of the historical make buy decisions they've made. And how they will be able to have a business model that makes money at those new production rates which will probably be sustained for perhaps the next 18 to 24 months. We think whether it's certainly Cessna, whether it's Hawk, or Beechcraft, whether it's Lear, Bombardier, frankly whether it's Emery Air, we think that we've got a lot of capability, we've got a very good cost structure, and a legacy of high quality from our employees. So we think that there is opportunities there but we have to go out and earn that business.

Okay. Thanks. In relation to K-MAX you talked about the demonstration that is coming up. There have been a number of articles -- is this the only solicitation that's out there, are there other people looking at K-MAX in unmanned form.

This happens to be a demo for the Marine Corp. The Army -- we've also demoed it for the Army. We are working with them as well. So there is a number of different areas that we are working right now.

How many K-MAX helicopters do you have in inventory right now.

Well we have three in conjunction with Lockheed Martin that we have dedicated to the unmanned K-MAX development and trials right now. We have the ability to take two others and rebuild -- modify aircraft that we have -- and then pass that, we would look at other avenues.

Okay. Thanks. Sticking with helicopters any news on the Seasprites.

We continue to work on sale of the Seasprites, in fact, we just had an update for our board at the last board meeting in mid-October. We have a number of opportunities, obviously we are focused on some of the existing users, such as New Zealand and Egypt today, because they are familiar with the aircraft. They've had very good in service performance of it. And may want the new aircraft with upgraded capabilities. And as well -- in Asia, there is a number of opportunities that we are looking at and in south -- in Mexico and et cetera. We've got a number of opportunities that we continue to work.

Okay. Thank you. Last one, 787 -- don't worry I won't ask you when you think it is going to fly, but it sounds like a few suppliers have come out with reports they are getting ready to ramp up and resume deliveries. How could that help Kaman?

That could help us. It's interesting Steve because as we look at our specialty bearing business from year to year and some of the decline that we've had it really breaks down into three areas. One as we talked about the business jet market as every one knows is down that 35% to 50%. And, even though that's historically only been about 15% of our business that's meaningful when 40% to 50% of that business goes away.

Obviously with lower utilization of the commercial air transport fleet and more aircraft being parked, our after market business is down, but year to year we are down on 787 as well. By a significant amount. As we look to the outlook for aerospace overall, one of the things we would like to see is clearly a ramp up of the 787. Between our composites business and our specialty bearings business, we've got about $220,000 of content on each aircraft. We would certainly like to see that aircraft begin to move through its flight test low rate initial production and move towards the first phase of ramp production which I think they said is five to seven aircraft a month. It would be a big help.

Thanks very much.

Your next question comes from the line of [Jim Fong with Cabelli & Company]. Please proceed with your question.

Good morning. Could you just walk through the time line for the unmanned helicopter on demo begins in December. If that passes the test, what happens after that?

Well, if as you said, the demo is in December, we've been told that they would evaluate, they would open up a bid, we would, even though we participated in the demonstration along with Boeing we would not be the only ones bidding on it. We expect that the time line would reflect early to mid 2010 contract bid and they're talking about deployment of three aircraft in theater yet in 2010.

When in 2010 would that be mid 2010 after the contract, --

Likely be late 2010.

So, in service late 2010. And, if things go well for you, if you get the contract, is it a shared contractor or is it all -- is it going to be one award or is it going to be an award that is going to be divided among different --

It would be -- are you talking Jim between ourselves and Lockheed Martin or between us and Boeing.

You and Boeing.

We don't know. The aircraft as you well know, Jim are fairly different in their lift capability. Especially at altitude. So it may be that there are -- they're looking at two different missions although I can't say that we know that for a fact. But the aircraft are very different. I don't think any of us would be surprised if there were a requirement for two different types of aircraft for two fundamentally differently missions.

Okay, so production could begin for you in mid 2010 if things go well for you then, right?

I would think we would put in service the aircraft that we currently have. And, if it were to move to a larger requirement, that's the point that we would look at going back into production. I doubt that we would go at a rate, Jim, where we would go back into production during 2010.

So, something like 2011? Yes. Okay, and then could you just talk a little bit about the Army demonstration. You mentioned that earlier.

We have done a number of demonstrations throughout both late 2008 and 2009. For the Army at various locations including Fort Eustis where we have done the unmanned version of the aircraft. We have always had a safety pilot on board. The difference here with the Marine demonstration in December out in Utah is that the requirement for the demo is that there is not a safety pilot on board.

We've demonstrated it with a safety pilot on board. We've demonstrated beyond line of sight operation. So now the fundamental difference between the two at this point will be the first time with a safety pilot out of the aircraft.

This is a different contract, the Army contract. From the Marines, right.

Yes.

What's the time lines on that. Is is there a date when you are going to demonstrate for the Army.

We've done demonstrations for them already. Jim I think what they are going to do, is they are going to obviously look at the results of the Marine Corps demo and then determine from that what their next steps are.

So that could lead to another contract for you if they like what they see in the Marine Corps demos area.

It's possible, yes.

Around the same time line basically.

I can't say -- I can't comment on what their time line might be.

Okay. Could you talk just a little bit about what you saw in the aerospace business by your different groups. More color in terms of the year-over-year changes by your subgroups or unit specialty bearings.

Well I will talk about some of the performance on various programs. We've -- I think we've covered specialty bearings and how that's broken down, and if you have specific questions, we can try and deal with those Jim. But obviously we've had a nice uptick from year to year, on our BLACK HAWK production. So that continues to ramp up, we were down slightly from the second quarter to the third quarter. That was more delivery timing. But we've -- approximately now are at full rate production on the BLACK HAWK but that's been a nice uptick.

We have continued to deliver on C-17 and look forward to the potential expansion -- or extension of that program that would take us now through 2011 even though we currently have orders through 2010. Certainly on 777 we continue to deliver at about seven ship sets a month on that. We know that that will ramp down the beginning of next year as they move towards a rate five, mid 2010. JPF -- obviously very nice improvement from year to year. And also our helicopter business up nicely year-over-year on the Egypt program. And also we've benefited both from additional spares to New Zealand for their SH-2s and our blade erosion coating business has grown nicely from year to year.

We commented earlier about expanding that now. We started with the BLACK HAWK -- we are now doing BLACK HAWK for both Sikorsky and the US Army, we are doing the Sea Stallion, we are doing the Apache for Boeing and now we added the new contract with Eurocopter as well for the Lakota. So we feel pretty good about the progress that we've made in winning new business and we look forward to the ramp up of things like [A-10] for us in late 2010. And also certainly if Boeing 787 or A380 begin to ramp up, that will certainly help us as well.

Thanks for the color, just a couple of few questions on 2010, do you know what your pension expense would look like in 2010 as well as your tax rate.

We have not given any specific guidance on 2010 yet. We do expect that pension could be slightly higher than this year which was $16 million. We haven't finalized that number. That will happen January. Tax rate for next year you can assume something closer to 35%.

35%, okay, great. Thanks a lot.

Your next question comes from the line of Jim -- excuse me, Jeff Hammond with KeyBanc Global Markets. Please proceed with your questions.

Good morning.

Good morning.

Neal, think I just on the aerospace progression, particularly Kamatics. I think you had mentioned we get this downtick into 3Q and then it should improve from there. Is it still the feeling that Kamatics has got this one quarter hole and then we are back to a normal level or are we seeing a new lower run rate just given the commercial headwinds.

I think we expected that the third quarter would be a low point because of the inventory adjustments and run down that we expected coming out of the business aircraft market as they adjusted down. I think what we are experienced looking out is a -- not lower than third quarter -- but with commercial aftermarket still being down, and 787 being down year to year, we expect to be up slightly as we said in the fourth quarter. But we didn't see a snap back until we get either rate on 787, increase on A380 or some of the aircraft coming back in getting ours on them and going through their normal maintenance cycles now they are not encountering because the cycles are down.

I know you are not giving 2010 guidance today but just you talked about a lot of moving pieces within aerospace and some nice new wins. If you take the commercial pressures together with some of these new wins, how should we think about aerospace directionally into 2010 -- does this business grow, is it ultimately down a little bit. Maybe just a little color on visibility into 2010.

I will tell you the things that we -- as we look at it, what we see as some of the pluses and minuses and as we get in to the year we will talk about how we might see it. But when you break it down, first of all, we see continued business jet weakness in to 2011. We don't think it's going to follow the normal pattern of recovering 12 months after the return of -- or the uptick in corporate earnings, I don't think we will see that.

The 777 rate reduction from seven to five next year will impact us. We've got a little bit over a $250,000 per aircraft on that. Single aisle rates everybody is talking about whether those will go down. Quite honestly it's a very small impact to us. So if Boeing were to reduce a rate or if Airbus were to reduce a rate on a single aisle, I'm not going to say we are immune to that but we've got very low content on it. We had planned this year -- so 2009 -- as weakening in aerospace at the end of the year and we were going to have that offset by 787 ramp up and A380 ramp up. Obviously those things didn't happen, so they've done a good job of expanding business with existing customers.

The defense side for us, which is still the majority of our business is pretty stable. BLACK HAWK as I've said we've gotten up to close to max rate production -- we might have two or three cockpits give or take from quarter to quarter. That's why the Bell win was so important to us to be able to expand into another rotor craft manufacturer and have an opportunity there. C-17 we know is going to be stable. End of the year, we've got A-10 ramp up. Joint Strike Fighter we haven't talked about very much but we've got about $120,000 per aircraft today and we're really working hard to ramp that up. But as that ticks up through 2010, into 2011, that will be nice for us, but I don't think it's going to be a year where we are going to have significant upside growth simply because of the downward pressure of business aircraft and commercial air transport aircraft.

That's good color. Wanted to come back to KIT on the margins. You saw a nice uptick in the revenues sequentially and a small uptick in the margins. I know you had the furlough in Q2 but I was under the impression that you were going to start to get cost saves to fully offset the furlough activity. So just on a sequential basis I would have thought you would have seen more of an incremental margin uptick. Can you talk about that? Should I assume for the fourth quarter that if you are thinking at the bottom end of the sales range we should think at the bottom end of the margin target range.

Yes. n fact, KIT management was able to more than offset the impact of the one time savings from Q2 so we were actually quite pleased with their performance in the third quarter with about a 10% margin improvement despite the lack of those one time savings. So we were quite happy with their results.

Fourth quarter, yes, based on October we are saying our sales will be at the high end of the range down 10 to 15. That means 15. Not 10. With that comes the lower margin in terms of the range we have given there as well.

Okay. But the restructuring savings, I thought that you were going get $4 million of restructuring savings second half versus first half. Is the restructuring savings coming in more muted?

No we are getting the savings we intended to get, they are baked into the numbers. hat's part of the forecast.

If you look at the progression from the first quarter, the 1.6% return in the first quarter, that's where we really incurred costs associated with that with -- the reductions in force. And also in the second quarter then combined with that reduction in force as well as furloughs during the second quarter, we brought that to a 2% return and then with the third quarter at 10 basis point improvement but those improvements are -- we are taking advantage of that lower cost base to get that.

Okay. Thanks, guys.

Your next question comes from Robert Kirkpatrick with Cardinal Capital. Please proceed with your question.

Thank you and good morning. Neal what does it take to penetrate other Rotorcraft manufacturers that you current don't do subcontract business for.

I think that we could look at Bell as probably a good example of that, Rob. We worked with Bell for a number of years to try and demonstrate that we had the technical capability to provide work for them on their rotor blades. And they visited us on a number of occasions. And then they got to the point where they got very comfortable with our capability and decided to make the move.

It is really important to us to be able to penetrate additional ones. If you look at it today, we've got Sikorsky, we've got Boeing, we have MDHI on the commercial side. We've now added Bell and we've added Eurocopter. It is a step where we can demonstrate that we've got the capability to do the work, that we've got a cost structure that's attractive to them, given the inevitable pressures they have today, and quite honestly as you've seen when you come through our facility -- and other folks that are on the call -- we've got the capacity to be able to meet that need as well. I think the time frame between award and actually beginning to deliver product on the Bell contract is a good indication of how responsive and that we can be.

Long answer I'm sorry but it really comes down to demonstrating that we have the capability, that we have the cost structure and the capacity to respond to their needs.

Bill, your cash flow from operations for the nine months is a vast improvement over last year's to perhaps understate things. How much of the improvement would be due to the shrinkage in the business at KIT, and how much would be due to perhaps some one time things that were associated with last year. Then finally how much is just due to perhaps running the cash aspect of the businesses a little bit better.

Right. Last year there was about $20 million of one ops. This year through nine months we are at $40 million of free cash flow. And roughly half of that is from KIT, and the other half from aerospace. And the KIT is primarily inventory reduction.

Okay. The aerospace would be a mixture of JPF inventory -- or sorry, JPF and a few other things?

Primarily inventory reduction there as well. Receivables are actually up slightly at aerospaces due to the heavier volumes on the BLACKHAWK. So it is primarily inventory reduction. We've had specific working capital improvement programs at each of the aerospace businesses all year and we track them monthly and I think that has paid some dividends as well.

Okay. Neal, how is Brookhouse fairing relative to your initial expectations and relative to year ago period.

Actually, Rob, they're exceeding our acquisition plan that we presented to the board both on operating earnings and cash from data of acquisition to today. I think what we likely may have underestimated was the capability of the management team. We thought they were very good, but they have been able to move through and meet that plan despite the delays in the Boeing 787, which was a key program for us that drove that acquisition. So it's been very well managed -- a great team there, very good customer relationships and they demonstrated that by being able to hit the plan despite a shift out of 787.

Okay.

We could use a few more of those guys.

Okay. Back to Bill. On the cash flow statement there was a loss on a change in the Australian payable net of the gain on the derivatives.

That was an add back to the cash flow. It's a negative on the income side but it's non-cash and it has to do with mark to market of the piece we didn't hedge and an adjustment due to the difference between the spot and forward rates on the hedge itself.

Okay. So where would that have showed up as a non-cash expense on the income statement.

Below operating profit -- other items I think it's called.

Other income or expense?

Yes.

Okay. Then finally Neal, with the recent hire of a Chief Operating Officer at KIT and a newly created role you mentioned that he had a global mindset. Is there is any thought to expanding the distribution business in the next couple of years outside the borders of the United States beyond where you exist -- you already are because you already are in Canada. And maybe in Mexico I'm not sure.

Yes Rob, we are in Mexico and obviously Puerto Rico as well. We look at it from two perspectives. As we've talked about the profile of people we want to add to our team here at Kaman, we think having global experience is important aspect of it because even our US national accounts such as Pepsi, Procter and Gamble -- they are really global accounts that we service nationally today. So even if we were not to expand globally I think it's important for us to understand the dynamics that our key customers face in those markets so that we can be more responsive to a their needs because a lot of their equipment comes from Europe, or increasingly, Asia as well.

We've really focused on getting people in that bring that experience and Steve earlier in his career, with Rockwell Automation spent an extended period of time in Europe heading up European sales and marketing for them. Specific to your question, right now we are focused on filling out our geographic footprint in the US, if we were to go globally with distribution it would have to be a very deliberate step by step approach where we would clearly have a value proposition for each of those national accounts as we would go to support them globally.

But that is not on the near term horizon for us.

Great, thank you very much. Appreciate your answers gentlemen.

Thanks, Rob.

Your next question is a follow up from the line of Matt Duncan with Stephens, Inc. Please proceed with your question.

I want to get back to the KIT margin for a second. Just to make sure I'm doing some math right -- if I take out the impact of the furloughs on the second quarter operating profit it looks like your operating margin would have been up around 100 basis points in the third quarter from the second. Is that accurate?

I haven't run those numbers but it sounds close.

Furloughs were about $1.05 million in cost savings, correct?

Correct.

Okay then that works out to about 110 basis points. If revenues are flat in the fourth quarter, with what you posted in the third, since you're probably going to need at least a 60 basis point sequential improvement in the fourth quarter from the third to be able to hit your annual operating margin guidance there. Where do you think that would come from. Were there cost cuts -- some additional cost cuts made in the 3Q that will be felt in full force in the fourth quarter -- what are you doing to help drive that margin improvement in the fourth quarter and beyond?

We are counting on a sales uptick. Even at the 15% we are seeing sequential increase in sales in Q4. And with 26% gross profits up, that's what's the primary driver of improved profitability.

But I guess if revenues were down in October from September, you would probably need that highest month to be the third month to get sales up for the quarter. Would that be accurate? You've also got four less selling days, so how do you make up for those to get revenues up sequentially.

We are anticipating a bit of a market recovery starting in Q4.

Okay. That's helpful. That insight is helpful. Then the last thing I've got, two very quick modeling questions. First on quarterly interest expense going forward -- now that you've renegotiated -- at your current debt balances what should that quarterly interest expense look like.

On a 12 month basis an increase of about $3 million.

Okay. So that would put quarterly interest expense $1.05 million give or take or is it below that.

$1.05 million is pretty close.

Okay. The last thing I've got is on the corporate expense side, I know you guys have been thinking that that was going to trend back up into the $9 million to $10 million a quarter range. It's been below $9 million a quarter for the last six quarters. Are you still thinking that corporate expenses are going to trend back up into that $9 million to $10 million range or are you going to be able to hold them down you think.

Pension expense is an issue. Also, we've assumed that each quarter going forward there will be X amount of due diligence cost, which we have not incurred -- external due diligence costs -- I'm hoping we are going to start to incur them as we move into 2010 when we find the right deals.

That's helpful, thanks, guys.

Your next question is a follow up from the line of Arnold Ursaner with CJS Securities. Please proceed with your question. Sir your line is open.

It's a follow up to James Fong's questions from earlier. Since you don't give the same breakdown you used to give in the past the Fuzeing business can be a very lumpy business and you didn't really comment whether you've had any unusual activity at all -- revenue or earnings-wise this quarter -- I'm wondering how much of an impact that may have had on aerospace margin.

Give me one second. When we look at it on a program to program basis, there was not a tremendous amount of -- at top level JPF was the driver there -- there was not a tremendous amount of difference from quarter to quarter, they were down slightly on some revenues. But program and timing related but not a big swing there, we had -- we focus primarily on JPF and that was fairly consistent from quarter to quarter.

No mix change towards more foreign military sales that would have impacted margin quite a bit.

No.

Okay. Remind us again --

And, Arnie, keep in mind that beginning in the second quarter of this year, with our option 5 that we are not going to incur the lumpiness of sale differential between FMS and US Government because that is contractually agreed to as part of option 5 -- the percentage. We account for that on a more consistent basis.

You mentioned under option 6 the revenue contribution increased from $53 million to $59 million. Is that more volume or is that strictly price and if it is price I would assume that goes right to your margin.

Well, Arnie I wish I could tell you that was all price but it was volume. So it was -- at similar pricing, additional unit volume. Which we were glad to see it go up from 53% to 59%. We would like to see -- excuse me $53 million to $59 million -- we'd certainly like to see additional drop in orders for that option.

But you're already operating essentially at a pretty high level of -- versus your capacity utilization. Is that correct?

We've -- they've done a tremendous job Arnie on ramping up and we've talked about the numbers earlier. But we now have both production lines up and running and authorized to produce the Fuze -- the new design of the Fuze -- so we could probably manage some additional upside volume.

This wouldn't just extend the time of the contract, you hope to deliver the higher dollar volume within essentially the same time frame.

At this point in time that's correct, Arnie.

Okay. Thank you.

This concludes the question and answer portion of today's conference call, I would now like the turn the call back over to Mr. -- excuse me -- to Mr. Eric Remington for closing remarks.

Thank you for joining us for today's conference call. We look forward to speaking to you again when we report year end results in February.

Thank you for your participation in today's conference call. This includes the presentation. You may now disconnect. Good day