Kaman Corporation
Q2 2017 Earnings Call Transcript

Published: 1 Aug 2017

[Operator:]

Good day, ladies and gentlemen and welcome to the Second Quarter 2017 Kaman Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to turn the call over to Mr. Jamie Coogan, Vice President, Investor Relations. Sir, you may begin.

[Jamie Coogan:]

Good morning. I would like to welcome everyone to Kaman’s second quarter 2017 earnings call. Conducting the call today are Neal Keating, Chairman, President and Chief Executive Officer and Rob Starr, Executive Vice President and Chief Financial Officer. Before we begin, I would like to note that some of the information discussed during the call will consist of forward-looking statements setting forth our current expectations with respect to the future of our business, the economy and other future events. These include projections of 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 those indicated in any forward-looking statements due to many factors, the most important of which are described in the company’s latest filings with the Securities and Exchange Commission, including the company’s 2016 annual report on Form 10-K and the current report on Form 8-K filed yesterday evening together with our earnings release. In addition, we expect to discuss certain financial measures and information that are non-GAAP measures as defined in applicable SEC rules and regulations. Reconciliations to the company’s GAAP measures are included in the earnings release filed with yesterday’s 8-K. With that, I will turn the call over to Neal Keating. Neal?

[Neal Keating:]

Thank you, Jamie. Good morning and thank you for joining us on today’s call. I would like to begin today with a review of the second quarter results and provide an update on important programs and drivers for the balance of the year. Second quarter results came in slightly stronger than expected primarily due to the margin benefits resulting from distributions productivity initiatives, which bolstered year-over-year performance. While it’s still very early, we are pleased to see the improvement in profitability at distribution for the quarter. At a consolidated level, our net earnings were $13.5 million or $0.48 per diluted share and marked a strong sequential improvement over our first quarter results. As a reminder, our volume and mix forecast in 2017 for aerospace will lead to earnings that are back half weighted with some sequential improvement in the third quarter, but still heavily weighted to our fourth quarter. On a comparative basis, in the second quarter of 2016, consolidated net earnings were $16.5 million or $0.59 per diluted share or $0.64 per diluted share when excluding $0.05 of acquisition-related costs. Lower earnings per share compared to the prior year was largely attributable to a decrease in operating profit at aerospace due to JPF customer mix for the quarter offset by increased operating profit for our bearing products, structures programs and distribution. Turning to aerospace, sales were $170.3 million for the quarter, down 7.7% compared to the prior year. Contributing to the lower sales was the shift in mix of JPF sales from DCS in the prior year to USG Option 12 in the current period as well as lower overall JPF shipments during the quarter. Aerospace operating income for the period was $26.3 million or 15.4% of sales compared to $30.5 million or 16.5% of sales in the prior year period. Year-over-year profit headwinds related to the JPF program were partially offset by an increase in sales for our bearing products leading to margin improvement in our self lubricating bearing products, in our high precision miniature bearing products, which we acquired with the GRW transaction. Additionally, we continue to gain traction on our efforts to improve the performance of our structures programs, which delivered strong year-over-year improvement. Before turning to distribution, I would like to highlight some positive developments at aerospace for the balance of 2017 and beyond beginning with K-MAX. In July, Lectern Aviation of China accepted the first two K-MAX aircraft off our reopened production line, which marks an important milestone for our aerospace group. Additionally, due to the increased interest in demand for these aircraft, we announced that we are extending the production of the K-MAX into 2019. Our team continues to identify potential customers and is working to secure additional orders for the aircraft. Turning to our JPF outlook, in the balance of the year, we expect increased profitability as our mix shifts to DCS shipments. This includes $93 million in orders that we had discussed last quarter for which we are awaiting an export license. During the second quarter, the Congressional notification period concluded with no formal objection. And shortly thereafter, we submitted all of the necessary documentation for an export license, which is progressing through the normal approval process. We anticipate receipt of the export license shortly and will begin deliveries in the second half of the year. Longer term, there continues to be a strong level of interest for the JPF. Currently, we are in negotiations on Options 13 and 14 of our U.S. government contract as well as a DCS order with a foreign customer, which will give us backlog into 2020. In addition during July, the U.S. government issued a solicitation for production for Options 15 and 16 of the JPF contract, with quantities as high as 25,000 units per option and we continue to see strong demand signals from additional international customers. Lastly, as we look into 2018 and ‘19 we are encouraged by the anticipated growth of a number of platforms that will enable continued growth in our bearing product lines such as the Airbus A350, Bombardier C Series, G7000 and the Joint Strike Fighter. Turning to distribution, organic sales per day improved 2.6% sequentially, but were down 2.6% when compared to the prior year. As expected, the productivity initiatives we have implemented – have put modest pressure on our top line performance. However, the offsetting benefits of these programs were clearly demonstrated in the quarter as we were able to grow operating profit by 15.4% compared to the prior year despite lower volume and expand operating margin by 90 basis points to 5.7%. The effort was broad-based across our locations and includes a shift in our approach to focus on the most value-added and profitable product categories, coupled with enhancements in our analytics to help better identify opportunities that can provide value to both command and to our customers. In the prior year, we recorded $2.1 million of cost associated with the implementation of these initiatives. And when we adjust for these costs in the prior year results, we see similar operating margins to those achieved in the second of 2017 despite the lower year-over-year sales volume. This speaks to the impact of these initiatives and demonstrates our ability to sustain the performance improvement. And now, I will turn the call over to Rob. Rob?

[Rob Starr:]

Thank you, Neil and good morning everyone. I would to begin by providing financial details and adding some additional context to our results before discussing our outlook for the remainder of 2017. Our GAAP diluted earnings per share were $0.48 compared with the prior year level, where we achieved $0.59 on a GAAP basis and $0.64 on an adjusted basis. This year-over-year decline was anticipated due to the change in the quarterly pattern and mix of deliveries in 2017 relative to 2016, most notably in our JPF program. Gross profit in the quarter was $135 million or 30.1% of sales compared to $143.8 million or 30.5% of sales in the prior year. Our continued strong gross profit performance was led by distribution partially offset by an unfavorable mix in aerospace particularly the mix of Joint Programmable Fuze, USG volume relative to the prior year. Operating income in the second quarter was $27.4 million or 6.1% of sales compared to $29.8 million or 6.3% of sales in the prior year period. The lower operating margin and profit was the result of lower sales compared to the prior year and impacts the gross profit discussed partially offset by lower SG&A. SG&A in the second quarter was $107.6 million or 24.0% compared to $113.9 million or 24.2% in the prior year. Lower SG&A relative to the prior year stem from the absence of a significant portion of the costs associated with our distribution productivity initiative in the prior year and improved operating efficiencies across the company. Before handing the call back over to Neal, I would like take a movement to talk through our outlook for the rest of the year. Based upon our first half results as well as the issuance of our convertible notes this past May, we have made a few modest revisions to our full year outlook. Beginning with distribution, we are raising the low end of our operating margin range to 5.0% to 5.3% from 4.9% to 5.2% previously, while modestly tightening our revenue range to $1.1 billion to $1.125 billion from the prior range of $1.1 billion to $1.15 billion. The midpoint of our operating income outlook for distribution remains on track from our prior outlook as we have been able to offset the impact of slightly lower sales growth with improved margin performance. We continued to expect distributions year-over-year daily sales rate to turn positive in the second half of the year. Our aerospace guidance remains unchanged with the sales in the range of $730 million to $760 million and operating margins of 16.5% to 17%. As we have detailed on this call, higher profit contribution in the second half is expected to come from a shift – the shipments of higher margin DCS fuse orders combined with continued strong execution in our bearings product lines. A highlight in the quarter was the execution of our 7-year, 3.25% convertible notes due 2024. This is a capital raise that will help us meet our long-term strategic goals. Following the completion of our convertible debt offering in May, our full year interest expense for 2017 will now approximate $19 million from our previous guide calling for $16 million. The majority of the increase is a result of the timing of the transaction and while this led to modest headwind to our reported interest costs, we were able to secure an after-tax long-term cash rate of approximately 2.4% over the life of the notes, when you include the cost of the cap called, while extending the weighted average duration of our debt portfolio to about 5 years. Excluding the cost of the cap called instrument, the annual after-tax cash rate of the notes is approximately 1.6%, largely in line with the after-tax interest rate of the 2017 convertible notes and the amount we paid down on our credit facility. Our full year consolidated tax guidance is unchanged at 34.5% and our weighted average diluted share count remains unchanged at 28.5 million shares. Turning to cash flow, we generated $10 million of cash in the quarter, in line with our expectations. This pattern is not unusual as we will typically use cash during the first half with incremental improvement as the year progresses. We continue to expect free cash flow between $70 million and $100 million approaching or exceeding 100% of net income once again this year. Our 2017 year end leverage is expected to approximate 2x debt to EBITDA, the low end of our targeted range. With that, I will turn it back over to Neal for his closing comments.

[Neal Keating:]

Thanks Rob. Halfway through the year, we are executing well and are well-positioned to deliver on our full year outlook. We are excited about the opportunities at both segments and are pleased to be in line with our expectations, as we enter into the back half of the year. And in closing, I would like to thank our investors for their interest and support in each of our more than 5,300 employees around the world for their dedication and commitment to delivering world class products and services to our customers every day. Now, I will turn it back over to Jamie for questions. Jamie?

[Jamie Coogan:]

Operator, may we have the first question please?

[Operator:]

[Operator Instructions] Thank you. And our first question comes from the line of Edward Marshall with Sidoti & Company. Your line is now open.

[Edward Marshall:]

Good morning, guys. How are you?

[Neal Keating:]

Good, Ed. How are you doing?

[Rob Starr:]

Good morning, Ed.

[Edward Marshall:]

I am okay. Listen, I am curious, at the low end of the aerospace guidance, you are showing about $30 million of sales growth year-over-year, but yes, you are flattish, actually down $1 million on the income at the low end, I am curious, I know the of the mix in JPF, but is there anything else there that’s some pressure to that operating line for aerospace?

[Rob Starr:]

Yes. Ed, this is Rob. It’s a good question, I think what I would say structures has improved as we have talked about year-over-year, but there is still a reasonable level of volatility in that, as we look to the balance of the year in terms of establishing our range. So that certainly thus far there are a number of discrete items on the aerospace side that can still move the margin, that’s why range is – we decided fully where it is.

[Edward Marshall:]

Got it. And then when we look at $93 million JPF order, I am curious how fast can you ship that, I mean how many quarters would it be for you to exhaust that backlog?

[Rob Starr:]

Yes. Ed, I mean that backlog, it all goes according to plan can likely be done within a quarter if needed. It really comes down to the shipping capacity, but we do have plans in place that certainly ship that over the second half of the year.

[Edward Marshall:]

Okay. And just a question on it survived a congressional vote and I am curious about your thoughts on why the attention this time around was it the customer, was it the size, do you think the opposition gets stronger or weaker going forward, any kind of color that you could add there? Thanks.

[Neal Keating:]

Ed, as you know it’s a very politically charged environment in Washington right now. And I think that it was a combination of just simply that in combination with the end customer.

[Edward Marshall:]

Got it. Thanks very much.

[Rob Starr:]

Thank you, Ed.

[Operator:]

Thank you. And our next question comes from the line of Robert Majek with CJS Securities. Your line is now open.

[Chris Moore:]

Hey, good morning. This is actually, Chris Moore for Robert.

[Neal Keating:]

Hi Chris.

[Chris Moore:]

Yes. Maybe just to talk – good morning, talk a little bit more, it looks like you had a great quarter in terms of the operating margins on the distribution side, just trying to get a sense as to know what’s possible 2 years or 3 years out from an operating margin standpoint, is 6% or 7% the ceiling, what do you think is realistic?

[Neal Keating:]

Chris, what we have talked about is our medium-term goal is to get that 7% operating margin. So that’s clearly what we remain focused on and when we crossover 7%, we will decide what the next target is.

[Chris Moore:]

Got it. Are there a couple – one or two kind of key milestones to get to that 7% level or…?

[Neal Keating:]

I would say it Chris, right now, it is the I think the biggest driver will be a combination of return to organic growth with the demonstrated ability to sustain the discipline around the productivity initiatives that we have been working at for a little bit over the last year.

[Chris Moore:]

Got it. And just kind of staying what the distribution, in terms of from a channel partner perspective, kind of what are you hearing there in terms of strengths and weaknesses and just trying to get a feel for how things are looking coming into Q3?

[Neal Keating:]

From a supplier perspective, everybody is looking for some continued growth in the – in the second half of the year. We have been up sequentially from the fourth quarter to the first quarter and then again from this first quarter to the second quarter. So we see from our key suppliers a belief that there will be continued growth although it will be at a relatively muted level.

[Chris Moore:]

Got it. And last question just from M&A standpoint just from a, it’s kind of overall perspective, is it active or is it kind of a slow time for you guys in terms of what the pipeline looks like?

[Rob Starr:]

Yes. Chris, I would say that it remains active. As I think we have demonstrated, we have taken advantage of opportunities when they arise, for example, the last two acquisitions that we did in aerospace were both within I think about six weeks of each other, so we have trouble with when the companies end up coming out for sale, so that’s kind of outside of our control. What is within our control of course is the level of rigor and discipline we put around how the capabilities that that company would offer will supplement what we have today. So we continue to be active, but we just haven’t been able to get one across the finish line here in the last several quarters.

[Chris Moore:]

Got it. I appreciate much guys.

[Rob Starr:]

Okay. Thank you, Chris.

[Neal Keating:]

Thank you, Chris.

[Operator:]

Thank you. And our next question comes from the line of Ryan Cieslak with Northcoast Research. Your line is now open.

[Ryan Cieslak:]

Hi, good morning guys.

[Neal Keating:]

Good morning Ryan, nice to hear from you.

[Ryan Cieslak:]

Yes. Thanks. I guess my first question, I just wanted to go back to the distribution sales trends and just maybe if you can give us some color Neal or Rob on how the quarter progressed by month, I know last conference call that you had mentioned July was positive year-over-year, it looks like it slowed down a little bit at least in the months of May and June and just some – any color on what was driving that, I know obviously some internal initiatives you guys are working on or any color on that would be helpful?

[Neal Keating:]

Yes. Ryan, good question, so as we have touched on in our first quarter call, we did see a year-over-year improvement in April. We did fall back a bit, most notably in the month of May, May was certainly a weaker result relative to the prior year as well was to leading to the 2.5% year-over-year decline. In terms of the drivers there, what I can tell you in the quarter when we kind of look at some of the broad product lines, as part of the productive [ph] initiative, we are certainly in terms of the product categories another set of demographics looking at opportunities where we can be most relevant and most competitive and where we feel that we are not well-suited and that we have certainly as part of the selected to not compete in certain low margin and profitable circumstances. So in term of the product categories bearings and power transmission was down year-over-year for the quarter, fluid power was actually up, so that’s encouraging. Where we saw the most in terms of the product categories decline were MRO supplies and some of the electrical products where as you can imagine some of those are very generic items where pricing is really a key competitive differentiator. So overall, we were very pleased with the performance, sequential growth in the quarter over the first quarter and I expect continued sequential growth as we go through the balance of the year.

[Ryan Cieslak:]

Okay, great. And then any color on July to square that ended up at this point either on a year-over-year basis or…?

[Neal Keating:]

July was essentially flat year-over-year.

[Ryan Cieslak:]

Okay. So then if I look at the guidance it implies at least the distribution on the top line, a decent bump up in terms of the year-over-year trends improving for you guys, what should be maybe the main drivers there, how should I think about what drives that improvement following, what’s been maybe more subdued second half or sorry first half for you relative to maybe what you are expecting here in the back half?

[Neal Keating:]

Yes. I mean Ryan keep in mind, in the back half of 2016 we did see a pretty meaningful step down in our volume from a daily sales rate of almost $4.5 million in Q2 to $4.2 million in Q4 of last year. So the comps get significantly easier as we move to the balance of ‘17 that combined with sequential growth consistent with what we deliver over the past couple quarters is really what drives that. So there isn’t a specific product category or customer base that’s really that we can identify other than based on the information we have in the field and believe and opportunities that we have in front of us. We are very comfortable that we would continue to see sequential growth as we move through the balance of the year.

[Ryan Cieslak:]

Okay, great. And then lastly on distribution, how should I think about the where you are at with the productivity initiatives at this point, is it – are pretty much in late innings or is there more to do where you can see incremental benefit at the margin level into the back half of the year?

[Neal Keating:]

Ryan, we think that we don’t think we are in the late innings. When we look across the product categories that we have worked so far on, there is certainly platforms and product categories that are still ahead of us. So we wouldn’t say that we are in the late innings at all. We are very pleased with the performance improvement the team has been able to deliver, the decision making process that they have in place around the opportunities that they pursue and how we work with our customers to reduce our combined costs in the costs of serve areas. So we feel pretty good that there is additional opportunities available to us in the future.

[Ryan Cieslak:]

Okay, great. And the last one for me Neal, just on aerospace, not really looking obviously for guidance for next year, but may be just maybe how should we think about starting to frame up aerospace into 2018 and maybe some of the puts and takes at least a very high level with regard to the various platforms that maybe rolling off little bit, but obviously there is ones that it seem like there is some positive momentum continuing to build with JPFs and certainly K-MAX well, just some color on that might be helpful in thinking about 2018 right now?

[Neal Keating:]

Okay. So you don’t want me to give guidance for ‘18, but you are asking about – I am going to refer back to the script in large part Ryan, because it’s really why we talked about some of the longer term opportunities that we see in the aerospace business. In particular, I will highlight just a couple. There has been a lot of discussion and talk around the JPF and I think when we look at the combination of being in the final negotiations that options 13 and 14 with the U.S. government right now with the solicitation that came out just within the last 30 days for options 15 and 16 with unit demand up to as many as 25,000 in each of those two. And the level of continued opportunity and negotiation that we are in with foreign military highlights the longer term strength of the JPF product line for us. The second is that you are right that, we were really pleased to deliver the first two of the new K-MAX aircraft to Lectern just last month. And we know that we will have the opportunity to continue that production now into 2019. So we are please not only with the new aircraft production and deliveries, but clearly what that means for us longer term for the ongoing service and support for those. And while we have had some transition in commercial aerospace with 777 rates coming down somewhat, what we are really excited about is the combination of the increase in the narrowbody product lines at both Boeing and Airbus where our content is relatively low, but when you are talking about increases of 10 or 12 aircraft a month that adds up very quickly for products that we are very efficient at making and also the strength of the Airbus A-350 that the new C-series beginning to be delivered. And again while it’s relatively small for us, it’s nice to see the joint strike fighter tick-up, because that helps us a little bit in the structures area and certainly in the bearings areas well. So we are – as we look out to ‘18, we have a number of positives and we have got some planning to go through in the second half of the year as to how we can be structured to take best advantage of those opportunities.

[Ryan Cieslak:]

Okay, great. Thanks for the color guys. Best of luck.

[Rob Starr:]

Great. Thank you, Ryan.

[Neal Keating:]

Thanks Ryan.

[Operator:]

Thank you. And our next question comes from the line of Steve Barger with KeyBanc Capital Markets. Your line is now open.

[Steve Barger:]

Hi, good morning guys.

[Neal Keating:]

Good morning Steve.

[Steve Barger:]

Just to make sure I heard correctly in terms of the cadence in the back half, you expect to drive sequential growth in 4Q versus 3Q, so a shift from the normal seasonal pattern that ramps through the back half?

[Neal Keating:]

Yes. Steve just clearly, it’s a little difficult to predict given the short cycle nature of the business what will eventually unfold. We are not anticipating as a pronounced decline that we saw last year and this year’s fourth quarter. Those year-over-year comparisons certainly are looking favorable at this point as we gather information out of the field.

[Steve Barger:]

The way you are modeling internally though, would you expect revenue to be up in 4Q versus 3Q or are you just won’t make…?

[Neal Keating:]

I don’t think you will – based on current expectations we don’t think there will be a material difference.

[Steve Barger:]

Okay. If distribution revenue growth remains weak, how much margin expansion can you drive from your productivity initiatives, for instance if revenue comes at the low end, could you be at the midpoint or higher on operating margin this year or would that be a stretch?

[Neal Keating:]

I think that would be a little bit of a stretch there, Steve. I mean, certainly we are very focused on operating expenses. I mean, the team has done a really great job at managing their G&A. So, certainly, if market conditions don’t materialize as we anticipate, we will certainly not be sitting back, we will be looking at how do we just manage our discretionary expenses to really deliver on the bottom line.

[Steve Barger:]

Understood. And I know you expect sequential growth in 3Q if that is a fairly modest increase, you would not expect to see the same year-over-year increase that you got in 2Q?

[Neal Keating:]

In terms of the year-over-year, you got to keep in mind and last year, we saw a sequential 2.5% daily sales decline to 4.35% in last year’s third quarter, Steve. So, even if we were to hold flat with where we are in the second quarter that would be flat year-over-year, right. So, we certainly are – based on all indications we would anticipate sequential growth. So, that’s really what’s driving the year-over-year favorability.

[Steve Barger:]

Understood. And just one question on JPF you have talked about it going through the normal approval process, we have heard the news reports about a lot of deputy level jobs having not been filled in Washington so far 6 months in. Does that have an impact on your confidence around the process and making that 4Q shipping timeline or is that kind of a separate issue?

[Neal Keating:]

I think that at this case – at this point we would believe it would be a separate issue. I think that, that would have had more impact earlier in the process than in the export license – export licensing itself.

[Steve Barger:]

Got it. Thanks for the time, gentlemen.

[Neal Keating:]

Okay. Thank you, Steve.

[Rob Starr:]

Thank you, Steve.

[Operator:]

Thank you. [Operator Instructions] And our next question comes from the line of Chris Dankert with Longbow Research. Your line is now open.

[Chris Dankert:]

Hi, good morning, guys. Thanks for taking my question.

[Neal Keating:]

Good morning, Chris.

[Chris Dankert:]

I guess first I am looking at here just in reference to the A10 program, I think in the materials you released, so there is about 5 in backlog right now, I think your production capability is a little more than that in the quarter. So does current guidance imply that program rolling off in the back half of the year right now?

[Neal Keating:]

Yes, it does.

[Chris Dankert:]

Okay, okay. Just one sort of point on that. And I guess…

[Neal Keating:]

You are exactly, right. Chris. It does reflect it rolling off in the second half of the year and there being a aligned gap before we would restart.

[Chris Dankert:]

Okay, got it. Got it. And I think the total number of chipsets in that potential run is what 242 something like that, if I am remembering right?

[Neal Keating:]

Yes. That’s exactly right. Good number. We have got that heard in our memory and you do too. That’s good.

[Chris Dankert:]

Right. And then I guess moving back to KIT, I guess any comment on the price impact in the quarter or kind of what you are expecting in the back half of the year, I think there has been some expectation for a bit more inflation now as demand is starting to come back. Are you seeing that expectation right now?

[Neal Keating:]

Chris, for the first time in a long time we are beginning to see some price inflation in the channel. So, obviously, we are pleased to see that, because we can benefit from it. We also want to highlight that we may have some near-term margin squeeze as we get price increases and because of the contract period with our customers would not be able to pass all of those price increases on, but we certainly would intend to be able to take full advantage of those price increases going forward. So, it’s nice actually after a long period of time of no pricing inflation to see at least a little bit of a beginning to show up.

[Chris Dankert:]

Got it, got it. And then I guess just to circle back on EBIT margin at KIT, I guess typically you see kind of a seasonal step down into the back half of the year just given the way volumes move, but I guess if we have got a fairly flattish total sales number through 2Q through 4Q, does that mean we can see a pretty stable EBIT margin in that business or is it going to be a bit of a seasonal move to that?

[Neal Keating:]

Yes. Chris, I think what we are expecting right now is a fairly stable operating margin profile. The implied back half of the year is roughly around 52 or so. So, certainly, through the first two quarters on a year-to-date basis we are 5%. We had a very strong second quarter as we just published, but we certainly feel much better about the resiliency of the business just given the team’s efforts on productivity initiatives or the types of business they are pursuing. So, we feel really good about where the business is headed.

[Chris Dankert:]

Understood. And then I guess the last one from me. It looks that you were able to ship on a couple of DCS, JPFs in the quarter, I guess, is that a catch up from a prior contract or where were those headed that you didn’t need the export license?

[Neal Keating:]

We would need an export license in any case, but that was an export license that was granted earlier. And you are right that was a good catch. Normally, we have some DCS shipments in quarter, where many times we do the first quarter was atypical. In fact, the second quarter as well was atypical with as higher percentage of USG sales. I think it was like 96% or 98% of our sales in the first half of the year, where U.S. government as opposed to a slightly higher mix of DCS sales, but that would have been covered with a prior export license granted either earlier this year or more likely during 2016.

[Chris Dankert:]

Got it. Thanks, again guys and congrats on the next quarter.

[Neal Keating:]

Great. Thank you.

[Rob Starr:]

Thank you, Chris.

[Operator:]

Thank you. And we have a follow-up question from the line of Ryan Cieslak with Northcoast Research. Your line is now open.

[Ryan Cieslak:]

Great, yes. Thanks for taking my follow-up. Just really quick in your prepared remarks you mentioned some of the MRO products being so slow on the distribution side and pricing being competitive. Can you just – where exactly are you seeing the most competition right now? Is it from some of the nontraditionals coming into the space or is it still maybe some of the smaller mom-and-pop local guys that are maybe being most competitive at this point?

[Rob Starr:]

Ryan, it varies. So as you know, it varies so much by local market that I wouldn’t want to characterize that in one way or another, because I think it could be proven to be wrong if you went to Chicago versus Boston versus Dallas. So, I think it’s a combination of things. I think what’s interesting though is that when we look at the – we have talked a lot about our productivity initiatives and what we are trying to accomplish through those. And I think our results in the second quarter demonstrated how we are able to do it or that we were able to do it. We just – we know that whether it’s in our automation control and energy platform, where we have been historically had a presence in commercial construction for things like panel boards, switchboards even lighting. We are not going to be as competitive nor quite frankly do we want to be than a lot of the electrical distributors that focus and specialize in that area. We have really deemphasized that over the last year. It’s impacting our top line, but we are seeing much better results at the bottom line. And then in some of the MRO supply areas that were down, there are areas in many cases, Ryan, that are classified for us as MRO supplies, but there are specific products that we source for customers and that is a service that we have historically provided it’s very important, but it’s also a service that we want to get compensated for. And if there are personal protective devices etcetera that historically we have sourced that that they can buy more effectively from another source, then come in and have us put that work in. We are happy to have – some of our customers do that.

[Ryan Cieslak:]

Okay, great. Thanks for that color. And then just really quick on the last one I had for Rob. Last quarter, I think you gave some color around the earnings cadence with roughly 50% of full year potentially coming into the fourth quarter. I know it seems like maybe the second quarter was a little bit ahead of expectations. But any update there or how should we think about maybe the cadence by earnings in the third and the fourth quarter?

[Rob Starr:]

Yes, Ryan, that cadence remains largely unchanged, which is why we didn’t really provide an update plus, minus couple of percentage points, which is common levels of noise in any given corner. It remains unchanged. So, we still are expecting roughly 70% plus in the back half of the year largely weighted to fourth quarter, with approximately 50% in the fourth quarter.

[Ryan Cieslak:]

Okay, great. Thanks, guys.

[Rob Starr:]

Thank you.

[Operator:]

Thank you. And we have a follow-up question from the line of Edward Marshall with Sidoti & Company. Your line is now open.

[Edward Marshall:]

Piggybacking on that question just a bit, the unusual I mean the $93 million orders unusually large DCS order for you, it’s coming in the fourth quarter and it’s really a big contributor to the earnings power of the business, knowing that it’s kind of unusual in size as we look out to 2018, is there something that you guys see that makes up kind of that shortfall on the profit line that could – that can help earnings within aerospace for 2018 and beyond?

[Neal Keating:]

Ed, we will start on a couple things; A, it’s a larger than normal DCS order historically, there is no question. As you know we have seen some significant increases in demand in JPF from the U.S. military and our foreign allied military. So the first question will be whether or not we continue to see relatively larger DCS orders than we have historically simply because the demand for both current usage as well as building inventory levels is higher than it has historically been. The second thing is that, it’s interesting because it’s a larger single order for us, but it just so happens that we are going to ship all of that and we intend to ship all of it in the second half of the year. Normally, we would have it be more spread out during the year simply because of the way that the cadence fell this year and having to fill the filler requirements for option 12 for the U.S. government as well as the initial delay in the licensing or the approval and now licensing process. So we will talk obviously at our first quarter call about what our expectations are, but as we have tried to highlight in every way that we can, we feel very good about the near-term and in medium term future for JPF. And it will be a mix of both U.S. government and foreign military orders.

[Edward Marshall:]

And when you say foreign military you mean FMS or DCS?

[Neal Keating:]

Combination of both, there will be FMS and there will be also DCS orders simply because of the timeframe in which FMS orders can be served through the current DoD contracting process.

[Edward Marshall:]

Okay. And as we move through say option 15 and 16 you talked about maybe the size that talks more about the length, but when I think about the size I think about room for say DCS shipments in a particular given year or given the government’s order parameters, would you have enough room to kind of in orders of 25,000 pluses fuses have room to ship something of this magnitude DCS order in the future in a particular quarter or year?

[Neal Keating:]

We are very pleased with the rate at which the team has been able to increase production and the continuation of the very high reliability levels that we are delivering in the field and we feel that we can continue the increase production rates certainly above where we are today to support demand from both U.S. and foreign customers.

[Edward Marshall:]

And what’s the rate amongst now?

[Rob Starr:]

We did about 16,000 in the first half of the year, about flat with last year. And we are at our look is 34,000 to 37,000 units for the year. We have been able to flex as high as nearly 1,000 JPFs in a week in terms of stress test and supply chain. So just to echo Neil’s comment, we have more than sufficient production capacity at this point based upon our demand outlook.

[Edward Marshall:]

Great. Thanks guys.

[Rob Starr:]

Thank you.

[Operator:]

Thank you. And we have a question from the line of Pete Skibitski with Drexel Hamilton. Your line is now open.

[Pete Skibitski:]

Hi guys. I apologize, I got on late. So if I repeat, sorry about that. Neal on A10, it looks like there is some decent amount of support for funding additional A10 orders, I am wondering depending on when we – I am guessing the ‘18 budget won’t kind of approve for a while, so I am just wondering how – can you keep the line open until late this year or early next year until we make another order or kind of how much fiscal pressure kind of will pull you to review you don’t get another order until next year?

[Neal Keating:]

Pete, we have anticipated and planned for a line gap in the A10. We will complete the delivery of the existing order of commitment later this year and then have a plan for line gap and we feel very comfortable and that’s incorporated into our outlook.

[Pete Skibitski:]

Okay, got it. And then on the H60 contracts, it looks to me like the original Sikorsky quarter was kind of averaging around 50 helicopters a year and I think there was something there for Saudi Arabia and then there was talk of options as well, I wasn’t sure if you guys would take part in the Saudi deliveries or not, but can you give us a sense of what this order implies, does it implies connected to units to European guys with the potential for upside or should we think about it differently?

[Neal Keating:]

I think you got it about right, the base demand would be about 50 a year, we could flex up to about that with an additional 20 so through about 70 a year. And I don’t know that we could make any statements at this point in the process really as to whether or not any of that incremental demand would be for Saudi.

[Pete Skibitski:]

Okay, got it. But we have you the margin distribution was outstanding this quarter, I think it might be an all-time high if my model is right, is there any reason you can’t replicate that again especially if volumes get better?

[Neal Keating:]

If volumes get better, yes we have given our outlook for the balance of the year and nudged up the lower end of our outlook. But we were very pleased with the performance in the second quarter and it was certainly we would like to see a return to organic growth and know that the team can convert that at a disproportionately higher rate of profit.

[Pete Skibitski:]

Got it, okay. And just I will give Robert one, Robert anything with regard to the changes in revenue recognition that are kind of coming down the pipe, I don’t know if you guys are planning that to hit in 2018 or are you expecting any kind of meaningful changes to the income statement when that comes through?

[Rob Starr:]

Yes. Pete, good question, we are certainly very focused on the new revenue standard. We have certainly setup a group here that has been very focused on the implementation as you had expected impacts a number of areas including our IT systems. In terms of the overall impact, we are still accessing what that impact is for 2018. Once we have a more definitive handle on that, we will certainly as required just close that in our financials. But certainly this is a high level effort and has significant resources on this. So we feel really good about where we are relative to the implementation at this – it looks like if this will go live in 2018 the current indications are that FASB will not provide another extension as they did earlier this year.

[Pete Skibitski:]

Okay. And Robert, on the cash flow guidance, obviously you got bit of a hill in the second half of the year, I am guessing that the DCS fuse order in the fourth quarter is potentially a big pacing item there and I am just wondering how confident you are in collecting that receivable in the fourth quarter to meet the cash guidance.

[Rob Starr:]

There are a couple of things Pete that are impacting our cash flow guide. As you mentioned, we certainly have as most share is a pretty significant hill in the back half of the year. But really what’s going to drive that certainly the DCS orders to a point, but the orders that would ship later in the year were largely going to likely collect those in ‘18 in any event. Really what’s going to also drive it is the bearings, increase in bearing sales as well as improving sales and execution on collections and distribution. So there are number of things. And then also we did have some impact on timing around K-MAX this quarter. We had roughly about $10 million of cash flow moved into the third quarter, just based on the timing of the delivery of the first two K-MAX. So K-MAX can also impact the timing here.

[Pete Skibitski:]

Got it, okay, very helpful. Thanks guys.

[Rob Starr:]

Thank you very much Pete.

[Operator:]

Thank you. And I am showing no further questions at this time. I would now like to turn the call back to Mr. Jamie Coogan for any closing remarks.

[Jamie Coogan:]

Thank you for joining us on today’s conference call. We look forward to speaking with you again when we report our third quarter results.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. And you may all disconnect. Everyone have a great day.