Kaman Corporation
Q2 2016 Earnings Call Transcript

Published: 29 Jul 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Kaman Corporation Q2 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today’s conference call is being recorded. I’d now like to turn the conference over to Mr. Eric Remington, Vice President, Investor Relations. Please go ahead, sir.

[Eric Remington:]

Good morning. Welcome to the Kaman Corporation second quarter 2016 earnings call. Conducting the call today are Neal Keating, Chairman, President and Chief Executive Officer, and Robert Starr, Executive Vice President and Chief Financial Officer. Before we begin this morning, please note that some of the information discussed during today's 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 2015 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 financial measures as defined in applicable SEC rules and regulations. Reconciliations to the most comparable GAAP measures are included in the earnings release filed with yesterday's 8-K, a copy of which can be found in the Investor Relations section of our Web site, which is www.kaman.com. With that, I'll turn the call over to Neal Keating. Neal? Neal Keating Thank you, Eric. Good morning and thank you for joining us on today's call. For the second quarter, we delivered solid financial results supported by strong aerospace growth and continued margin improvement in our distribution business. At the consolidated level, sales increased 5.4% versus the prior year to $470.6 million. This increase reflects higher Aerospace sales, driven by double-digit organic growth on record high fuze sales and the recent acquisitions of EXTEX and GRW. Aerospace sales gains were, as anticipated, somewhat offset by lower Distribution sales. In our industrial distribution segment, sales remained under pressure, as expected, declining 5.9% to $286 million. But with good cost controls and our productivity and efficiency efforts, we delivered operating margin of 4.8% despite the lower volume. On a GAAP basis, diluted earnings per share were $0.59, including $2.3 million or $0.05 per share in one-time cost from recent acquisitions compared to $0.77 during the comparable period of the prior-year, which included $4.4 million in discrete tax benefits. Adjusted diluted earnings per share were $0.64 compared to $0.63 in the prior year. Moving to our segment performance, Distribution sales of $286 million reflects a 7.7% decline in organic sales per day during the period. Lower sales were the result of end market weakness, particularly in mining and energy-related markets compared to the year-ago period. I would also like to highlight that the second quarter of 2015 represented an all-time high level of sales at $4.8 million per day, making the year-over-year comparison challenging. That said, we are encouraged that volume has stabilized as sales per day were consistent with levels seen in the first quarter of 2016. As we discussed in previous quarters, we continue to be focused on continuous improvement initiatives and cost controls and we are continuing to see these initiatives pay off as, sequentially, margins increased by 120 basis points. This resulted in segment level operating profit of $13.8 million, a 32% sequential increase over the first quarter, which we feel is a very good result, given the relatively flat volumes. In our Aerospace segment, we booked strong sales growth of 29.7%, with sales of $184.6 million during the quarter, driven by an $18.1 million contribution from EXTEX and GRW and an exceptionally strong quarter in our fuze business. As Rob will detail in our guidance, we expect strong segment level sales to persist through the balance of the year, primarily driven by fuze backlog, solid bearings performance, and recent acquisitions. We also had positive developments relating to SH-2 programs, securing the next phase of the Peru program with $50 million now under contract. We also entered into a three-year contract to assist the Egyptian Air Force in the development of an in-country depot maintenance facility to support their fleet of ten SH-2 aircraft. In addition, the Egyptians have acquired seven SH-2Gs that were formerly US Excess Defense Articles and we are in discussions with NAVAIR and the Egyptian Air Force to upgrade these aircraft and return them to service. If successful, it would bring Egypt's fleet of SH-2s up to 17 aircraft and the worldwide fleet up to 36 aircraft. The redeployment of SH-2 aircraft globally is expected to be a meaningful contributor to the segment going forward, potentially representing a doubling of the flying fleet in just a few years. Segment level operating profit increased 4.5% to $30.5 million, driven by higher sales during the period. This improvement was partially offset by lower margin related to our mix of business and underperformance, most notably on our A10 and Boeing 777 structures programs. Looking forward to the second half of the year, and as Rob will detail in our guidance, we are reducing our full-year profit expectations in our Aerospace segment as we expect pressure from several structures programs to continue for the balance of the year. Turning to recent acquisitions, EXTEX and GRW Bearings, I am pleased to report that we expect both to be slightly accretive to GAAP EPS for the full year. Our results include one-time acquisition and integration cost of $2.3 million for the second quarter and $4.3 million year-to-date. In our fuzing product lines, second quarter JPF fuze shipments exceeded 9,000 fuzes, an 80% increase over the comparable period in the prior-year. We've made excellent progress in our efforts to increase JPF production to meet customer demand, supported by a strong pipeline of orders already in our program backlog of more than $230 million. In addition, we continue to pursue opportunities for additional orders, including the next Air Force contract and a recent approval by the Defense Security Cooperation Agency of a possible FMS sale to the UAE for almost 15,000 JPFs, which would bring production visibility into 2020. So halfway through the year, we are pleased with our performance and excited with the success of several of our strategic priorities including our execution on the JPF program, the performance of our acquisition, the operational performance of our bearing product lines, and the prospects for our SH-2 programs and, of course, improvements in the profitability of our Distribution segment. As we look to the second half, we are well-positioned to deliver on our commitments and address the challenges we face in certain end markets. Now, I would like to turn it over to Rob to provide you with some additional details.

[Robert Starr:]

Thank you, Neal, and good morning, everyone. I’d like to begin this morning by providing financial details and adding some additional context to our results. GAAP earnings per share was $0.59 compared with $0.77 in the prior-year. And on an adjusted basis, diluted earnings per share was $0.64 compared to $0.62 in 2015. This year, the primary difference between our GAAP and adjusted earnings per share were costs related to the acquisitions of EXTEX and GRW. In the second quarter of the prior-year, a change in Connecticut tax law benefited our diluted earnings per share by $0.16. This had the effect of decreasing our effective tax rate to 20.3% versus the 35% in 2016. Earlier, Neil provided an overview of results for the segments and we thought it would be helpful to provide some additional color on the Aerospace operating profit performance. On a GAAP basis, operating margin declined 400 basis points to 16.5%. This decrease was driven by acquisition and integration related costs of $2.3 million, incremental intangible and fixed asset step up amortization of $1.4 million as well as negative EAC retro adjustments related to the underperformance in certain of our structures programs Neal mentioned earlier. Moving to the consolidated results for the period, our gross profit performance was strong with a margin in the quarter of 30.5%, our first ever quarter above 30%, also representing a 90 basis point improvement over the prior year. This improvement was largely driven by improved gross margin performance at Distribution, which has benefited from our continued efforts to improve customer service through the use of enhanced data analytical tools. The higher mix of DCS JPF sales in the quarter also contributed to the improvement in gross margin. Taking a closer look at SG&A expenses, we experienced an 11.7% increase in consolidated SG&A, primarily the result of increased SG&A at Aerospace, driven by the addition of expenses from our acquisitions. Organic SG&A increased 5.3% over the prior year period and was driven by the release of previously capitalized G&A, costs associated with the production ramp up of our JPS program and business development and IR&D costs at our specialty bearing product lines as we invest in future growth opportunities. Our balance sheet position remains strong as we ended the quarter with a debt-to-capitalization ratio of 44.2% and a debt-to-EBITDA ratio of 2.9 times, within our long-term target range. I would like to turn to an update of our 2016 outlook. Based upon the performance through the first half and the increased visibility it provides, we have updated our expectations for the balance of the year and we've made corresponding adjustments to our full-year outlook. At Aerospace, we continue to expect significant top line growth and we have raised the lower end of our sales range to $710 million from $700 million and the top end of the range to $725 million from $720 million. This corresponds to an increase of between 18% and 21% year-over-year. We now expect full-year Aerospace operating margin to range from 16.8% to 17.1% or 17.6% to 17.9% when adjusted for one-time acquisition-related costs of approximately $5.5 million, primarily involving inventory step-ups and integration expenses. Our reduced profit expectations are primarily driven by the underperformance we encountered on a number of our structures programs in the first half. Also, impacting margin expectations are slightly lower sales for some of our bearing product lines, most notably military and commercial engines, large business jets and our flexible driveshaft, which is tied to the helicopter market. While we are encountering soft demand in a few end markets, the overall performance of our bearing product lines remains very robust and they continue to be significant contributors to the segment's overall profit. Continued strong performance on the JPF program will help to partially offset some of the headwinds we’re seeing in other areas of our product line portfolio. Looking at Distributions, the relatively stable daily sales rate we've achieved over the last several quarters gives us the confidence to maintain the lower end of our sales range at $1.125 billion. However, we are lowering the high end of the sales range by approximately 1% from $1.165 billion $1.15 billion. Our expectation remains that our comparative organic growth rates will improve slightly in the second half as the comps become easier. Given our solid operating margin performance at Distribution through the first half of 2016 and our building confidence in the effectiveness of our productivity initiatives, we are raising our operating margin expectations for the year to a range of 4.5% to 4.8% from our earlier range of 4.4% to 4.6%. Our projection for quarterly net earnings cadence remains weighted towards the fourth quarter, with approximately 35% to 40% of our full year net earnings occurring in the fourth quarter. The primary driver of this result is improved performance across most of our Aerospace programs, in particular at our bearing and JPF product lines as we move through the balance of the year. We remain on track to achieve our expected net cash provided by operations of $80 million to $100 million, resulting in a free cash flow outlook range for the year of $50 million to $60 million, which is within our long-term target for free cash flow conversion of 80% to 100% of net income. Our outlook for 2016 produces a three-year average free cash flow conversion rate in excess of 100%. With that, I'll turn it back over to Neal for his closing comments. Neal?

[Neal Keating:]

Thanks, Rob. I'd like to close with just a few comments highlighting both our near-term performance and several developments that will help drive longer-term growth across Kaman. In Aerospace, the diversity of our products and the markets we serve has been one of our key strengths and this quarter was no exception. While our structures business dealt with several program-related issues, we had solid contributions from our AVMRO and bearing product lines and exceptional performance by the JPF team in the quarter. We are also encouraged by the early contributions of our new acquisitions. And just this month, we have begun moving production into our new bearings expansion in Bloomfield. And as we look to the longer-term, we see continued strong JPF demand and new opportunities to expand the fleet of both SH-2 and K-MAX aircraft. In Distribution, the team has made consistent progress over the first half of the year in improving our operating margin despite continuing weakness in industrial markets. While we're all hoping for some improvement in the market during the balance of the year, we remain focused on what we can control – managing costs, driving productivity improvements, and serving our customers. Overall, we’ve seen progress so far in 2016 and are poised to capitalize on the foundation laid heading into the second half of the year. With that, I’ll turn it back over to Eric for questions. Eric?

[Eric Remington:]

Thanks, Neal. Candice, may we have the first question please?

[Operator:]

[Operator Instructions] And our first question comes from Matt Duncan of Stephens. Your line is now open. Please go ahead.

[Matt Duncan:]

Hey. Good morning, guys.

[Neal Keating:]

Good morning, Matt.

[Robert Starr:]

Good morning, Matt.

[Matt Duncan:]

So, Neal, the first question I’ve got, you guys had a really nice sequential improvement in KIT, in the operating margin there with basically the same amount of sales, 120 bps is a pretty big improvement. Can you talk about how much cost you took out of the business on a permanent versus maybe a more temporary basis with sales depressed there right now and maybe update us on your longer-term operating margin goals for that segment?

[Neal Keating:]

Good morning, Matt. If we were to look at the cost that we’ve taken out of that business, I think you’ll remember that, in the fourth quarter, we talked about $7 million of costs that would come out due to some of the restructuring that took place in late 2015. We do have some cost offsetting that as we do merit increases and other incentive programs during the course of 2016. But I think that you could probably go to maybe two-thirds of that $7 million number.

[Matt Duncan:]

Okay. And then the long-term margin plan for that segment?

[Neal Keating:]

Matt, it stays the same. Our long-term operating margin goal for that business is 7%. And I think that if you look at the kind of improvement that team delivered in this quarter on flat sales, it’s indicative of the programs that they are putting in place to enable us to make strides towards that number despite a lackluster demand environment.

[Matt Duncan:]

Okay, that’s helpful. And then in terms of the monthly sales progression, it sounds like you're starting to see a little bit of stabilization. Obviously, the comps are going to get easier as we move into the back half of the year. But can you maybe tell us how organic sales tracked on a monthly basis through the quarter and here into July?

[Neal Keating:]

Sure. We did see some variability from month-to-month, but a lot of that is due to the year-on-year comps. We were down a little bit more than 9% in April, between 4% and 5% in May, and between 8% and 9% in June. So June was relatively weak. But, again, June was a very strong month for us a year ago. As you know, we’re not done with July yet; but on a run rate basis, we’re between 4% and 5% down organically. But we’re right at the same daily sales rate as we've been really since the fourth quarter of last year.

[Matt Duncan:]

Okay. So still tracking it roughly at that daily sales rate. Okay, that’s helpful.

[Neal Keating:]

Yeah, that’s right.

[Matt Duncan:]

All right. And then last thing from me, just, Rob, on how should we think about Aerospace sales and margins trending for the next couple of quarters to get to your guidance range, how big of a difference are you anticipating between the 3Q and the 4Q?

[Robert Starr:]

That’s good question, Matt. Certainly, Matt, when you look at 35% to 40% of our net earnings occurring in the fourth quarter and certainly Aerospace is the primary contributor to that, we are stepping [ph] a very strong quarter. So I think what you’ll see is in the range of a, call it, 5% to 10% quarter-over-quarter top line, a negative outcome for Aerospace going from Q2 to Q3, and then you can kind of plug for the fourth quarter based on our sales outlook range. But probably down by about 5% to 10% top line quarter-over-quarter in Aerospace.

[Matt Duncan:]

So something on the order of $170 million or a little bit less in the 3Q. And that implies the midpoint of the segment guidance got to be $200 million in the fourth quarter. Is that right?

[Robert Starr:]

Yeah, you’re right in the neighborhood.

[Matt Duncan:]

And then margins, are margins going to be pretty different between the two? I would assume so, given that revenue difference.

[Robert Starr:]

Yeah. Certainly, the primary contributors in the fourth quarter, we are stepping [ph] a very significant quarter in bearings, similar to prior years, and it’s certainly – just the expected timing of deliveries of JPF, in particular DCS deliveries in the fourth quarter, are really driving the differentials that you see. But we’re also expecting improvements in other Aerospace programs as well. So I want to make sure that pay them the credit that’s due. We have a lot of people working to improve the performance.

[Matt Duncan:]

Okay. Thanks, Rob.

[Robert Starr:]

Great, thank you.

[Operator:]

Thank you. And our next question comes from Ryan Cieslak of KeyBanc Capital Markets. Your line is now open.

[Ryan Cieslak:]

Hey, good morning, guys.

[Neal Keating:]

Good morning, Ryan.

[Robert Starr:]

Good morning, Ryan.

[Ryan Cieslak:]

Just first off, at KIT, the margins, really nice performance there considering the weakness on the top line. If I look at the updated guidance, it does imply ongoing sequential improvement in the margins into the back half at Distribution. I just wanted to get a sense of what's the assumption there, what's driving that, are there additional cost take-out or cost measures you guys are looking to deploy, maybe give some color around that would be helpful.

[Robert Starr:]

Ryan, this is Rob. So you are correct that the guidance would certainly imply a modest improvement as we go through the balance of the year. The implied range is 4.8% to 5.4%, just doing the math. So, really, what’s driving that is really more of the same that you’ve seen between Q1 and Q2. We continue to make strides, as we’ve touched on, our productivity initiatives. We are gaining traction there. And certainly, some of the costs that we’ve incurred in rolling that out through the organization. We do begin to lighten up a bit in the fourth quarter, so that will certainly help us as we move forward. But it’s really just operational execution and really more of the same through the balance of 2016.

[Ryan Cieslak:]

Okay. And then, Neal, thinking about maybe sales by product line at Distribution, I know you sometimes give color on that. Are you seeing any differences on how things are trending there with regard to fluid power versus bearing versus other areas, just some color there would be helpful?

[Neal Keating:]

We haven't seen a marked difference. Our strongest area continues to be our automation control and energy product lines and systems, which we’re actually pleased with considering a very high percentage of that business or a significant percentage of that business is OEM driven. And we all know the strong dollar certainly hurts our exporting OEMs. Our weakest area, again not surprising and consistent with the past four quarters, is fluid power. And our traditional bearing and power transmission is kind of between the two. So weakest in fluid power and strongest in AC&E with our mechanical power transmission and motion control business kind of in the middle.

[Ryan Cieslak:]

Okay, great. And then on to Aerospace, I guess, just maybe I wanted to dive in a little bit to the weaker performance you’re seeing in some of the structure programs and how do we think about that into the back half of the year? Are there other programs that you think could see additional weakness? Is this something that you think is correctable or maybe is a little bit of lagging impact here going forward?

[Neal Keating:]

Ryan, we certainly think it's correctable and we've had significant efforts across the Aerospace group focused on both the programs and the facilities where we’ve been encountering issues over the course of the year. So I know that that hard work will continue. The two key areas where we've seen weakness are the A10 and the Boeing 777 aircraft programs. And, really, it breaks down to – we've had some operational challenges internal to our own facilities and our supply of parts to the final assembly areas has been spotty. So that has that resulted in higher-than-anticipated hours for assembly and production. And also, in order to meet some of the challenging cost targets that have been set by our customers, we've had an ongoing program to move some of our production to our lower cost facilities in Mexico. And because of some of the disruptions, we’ve delayed that, and so it's taking us longer and, therefore, costing us more than we’d anticipated as well. So three or four factors contributing to the underperformance in those areas. But as I said, we do have a very focused effort underway to help mitigate those issues through the course of the year. I think we still face some risks, but we think we have the right people focused on it.

[Ryan Cieslak:]

Okay, sounds good. I’ll jump back in the queue. Thanks, guys.

[Neal Keating:]

Great. Thanks, Ryan.

[Robert Starr:]

Thank you, Ryan.

[Operator:]

Thank you. And our next question comes from Chris Dankert of Longbow Research. Your line is now open.

[Chris Dankert:]

Hi. Good morning, everyone. Thanks for taking my question. I guess, first off, I didn’t see anything in the release and it wasn't brought up right away, so I am assuming no. Was there any update on K-MAX new orders, new showings, any new opportunities on that front?

[Neal Keating:]

Thanks for asking, Chris. In fact, we were all watching the K-MAX operate about two weeks ago here because we're actually using it as we were doing our facility expansion for bearings. We’re replacing some of the heavy equipment using the K-MAX. We continue to be in a position where we have five firm orders, three additional contracts on that. We have been very active in trying to bring additional orders in. One of the challenges that we have right now is that many of our operators, in particular the commercial operators, are in the middle of a very, very heavy firefighting season and their focus is not on negotiating new contracts for K-MAX, but rather meeting their requirements for supporting the firefighting efforts, in particular, out west and in Southern California. The marine programs continue to make progress. As we talked about, we’ve deployed the two aircraft to the Yuma training facility and we continue to work with them towards a program of record. We’re working very hard to get some language in the upcoming budget that would recognize the need to expand that. But we are not there yet. So very actively – we would love to be able to have had an update reflecting additional orders, but we're not quite there yet.

[Chris Dankert:]

Okay, great. That’s really helpful as far as trying to think about that program. And then, I guess, kind of moving to another big aerospace opportunity, the Peru SH-2, is there any color that you can give us on timing or kind of how that's expected to roll through.

[Neal Keating:]

It’s actually going to begin to accelerate in the second half of this year. It’s one of the upsides to us in the second half of the year and will run for a couple of years from there. So as we commented both in an earlier press release and also in our prepared remarks, the Egyptian Air Force has also now procured an additional seven SH-2s from the US. So we would certainly like to be able to have an upgrade program and depot level maintenance program for those seven aircraft that would fit in nicely after the completion of the Peru program. Lot of work to do by the Aerospace team to make that happen. But that’s certainly what we’re focused on next for the longer term.

[Chris Dankert:]

Okay. Just to, I guess, put a fine point on it, a chunk of that $50 million from the implementation in Peru will be in the back half of this year then?

[Robert Starr:]

Chris, this is Rob. Some of that $50 million certainly will be in the latter part of this year, most of it really falling in the fourth quarter. A good portion of the $50 million will be between 2017 and 2018.

[Chris Dankert:]

Okay. Okay, thank you. That’s helpful. And just one last one, if I might. As far as KIT, can you give us any color on kind of how price impacted the quarter and what you're seeing there?

[Robert Starr:]

Chris, this is Rob. The pricing environment remains very muted. We really are not seeing anything on price. It’s been a very stable environment. There really hasn't been much pressure up or down really, collectively across our different products.

[Chris Dankert:]

Okay. And just to clarify, flattish roughly for you guys and we’ve seen…

[Robert Starr:]

Yeah.

[Chris Dankert:]

Okay, thank you. I guess, a lot of other peers have been seeing negative price mix. I guess that's a positive and certainly helped your margin, obviously. So I’ll leave it here. Thanks so much, guys.

[Robert Starr:]

All right. Thank you, Chris.

[Operator:]

Thank you. [Operator Instructions] And our next question comes from Shannon Burke of Gabelli. Your line is now open.

[Shannon Burke:]

Hi. Good morning. Thanks for taking my call.

[Neal Keating:]

Good morning, Shannon.

[Shannon Burke:]

So I just had a quick question. The acquisition expense, $20 million, if you could parse it out, how much of that is related to the integration of GRW?

[Robert Starr:]

Sure. The $2.3 million that we refer is predominantly integration. We had about $1 million of step up in the quarter. That portion relates to integration expenses.

[Shannon Burke:]

Okay. And then, you had a slight build in working capital in the quarter, in the accounts receivable, is this related to some of the Aerospace issues? I don’t know if you could just go over…

[Neal Keating:]

Sure. Really the largest driver of the increase in accounts receivable during the quarter was really the DCS shipments that we made in Joint Programmable Fuze because those shipments were done towards the latter part of the quarter and we’ve said we collected it under receivables.

[Shannon Burke:]

Okay. And then on the fuzing business, the backlog is about $230 million you said. Could you breakout how much of that is international? And where do you expect the backlog to end up? Is it supposed to be flat? I know you talked about UAE, potentially, orders there.

[Robert Starr:]

Shannon, we have not historically broken out the backlog between DCS and USG. Certainly, a considerable portion of that is DCS. Just given [indiscernible] some of our Middle East customers. So by rough order of magnitude – I’d hate to give a percentage, but certainly – a considerable portion of it is DCS at this point.

[Shannon Burke:]

Okay.

[Robert Starr:]

In terms of the backlog going forward, we’re certainly pursuing additional sales, as Neal mentioned. We have the UAE potential order that’s out there. We also are working with the Air Force on their next lot or order point. So, certainly, it’s an important program for us. It has been a meaningful portion of our backlog. And we would expect, going forward, for that to remain the case.

[Shannon Burke:]

Okay. Does that Air Force contract have – would a continuing resolution hurt that or no?

[Robert Starr:]

It’s not tied to the continuing resolution. This is something where the Air Force is looking at their operational requirements. This is something that will be a part of – I believe of the 2017 budget as well.

[Neal Keating:]

Shannon, you raise a good point. The fact that they have been operating under a continuing resolution is really impacting the ability for us to move the K-MAX towards a program of record because with a continuing resolution there – it's very atypical for new programs to be started. The K-MAX deployment to Afghanistan was done under an urgent operational need, which is really the only way that you can do a smaller new program when you are operating under a continuing resolution. So very good point.

[Shannon Burke:]

Okay. Thank you. And then just on the structures business, you said 777 is one of – an area where you see issues. Would this have any effect on the 777X? Are you still in negotiations for position on that as well?

[Neal Keating:]

Shannon, I would like to say that they’re separate. We've been a long term, very good supplier to Boeing. And while we’ve encountered some issues very recently, we continue to have a very strong relationship with Boeing. We're bidding additional work across our business for the 777X. We have additional business in our engineering services business today. We’ve been successful in a number of new wins across our bearing business. And we are also certainly very active, bidding on the structures side. So we think the 777X will actually – we would like to be in a position where we will have more content on that than we do on the current legacy 777.

[Shannon Burke:]

Okay, great. Thank you so much. And congrats on a great quarter.

[Neal Keating:]

Great. Thank you, Shannon.

[Operator:]

Thank you. And our next question comes from Ryan Cieslak of KeyBanc Capital Markets. Your line is now open.

[Ryan Cieslak:]

Hey, guys. Just a couple of follow-ups, if I may. The first question I had is, I know it's still early, but when you think about 2017 in Aerospace and maybe the mix of the backlog and how that might be deployed or run out into next year, how should, directionally, should we be thinking about maybe the margin profile into next year? Do you view mix as a net negative, net positive or more neutral than anything?

[Neal Keating:]

Ryan, from a strategic planning perspective and a four-year rolling quarter forecast perspective, we look at that, but we’re really not that granular on 2017 yet. As we look at it, I think that we will have full-year contributions from the acquisitions without the integration costs and the step-up. We have very strong backlog on JPF, but the margin will vary on an end customer mix between DCS and USG and that’s really hard for us to determine this far in advance. So I would wait for any guidance on that, but it's a – as you know, Aerospace is a relatively long-cycle business. We’ve tried to highlight those areas where we see us strengthen our business with additional SH-2 business for Peru. Our bearing business continues to demonstrate solid growth and certainly we want to have some of the operational issues that we've encountered in the first half of this year behind us. I think that's the best characterization that I could make right now.

[Ryan Cieslak:]

Okay. No, that’s fair enough. And then on Distribution, I'd be curious to know what you guys have seen, if anything, with regard to maybe customer plant shutdowns in this past quarter and maybe what the expectation is going forward? I know some of your peers have talked about that and just would be interested to hear what you guys are seeing out there with regard to just overall plant utilization.

[Robert Starr:]

Ryan, we haven't seen that in the year-to-date. We've had slowdown certainly in the mines and other areas that we’ve talked about quite a bit. But I don't know that we have anything related to specific customer plant shutdowns. I think what – if I were to read the tea leaves or provide some tea leaves maybe, where we would be more cautious is whether we would see a higher frequency of that in the fourth quarter of this year, if demand remains low, whether or not some of our industrial customers will elect to shut down their plants for an extended period around the Christmas break. So that might be one of the reasons that you'll see some either pessimism or some risk factors highlighting that. And I think that we are cognizant of that, but we haven't seen it so far this year.

[Ryan Cieslak:]

And then, Neal, oil and gas has been certainly a weak area for everyone. But are you seeing any incremental activity coming out of those end markets, those customers here recently. I know oil has been volatile. But just be curious to know if there's any incremental activity you’re seeing within those end markets right now.

[Neal Keating:]

Ryan, we were kind of pleased to see that, sequentially, our oil, gas and mining business collectively, which is how we look at it, was pretty much flat. So we were glad to see it not decline any more sequentially, but it was still a significant decline from year-to-year, between 30% and 35%. So it was a big deal. We did comment even in our prepared remarks about the second quarter of last year being a record high sales for us. And if you think about – even though oil, gas and mining is a relatively small part of our business, when that's down 35% from year to year, it’s a big impact. But we were glad to see it stabilize on a sequential basis from the first to the second quarter.

[Ryan Cieslak:]

Okay. Thanks for the color, guys. I appreciate it.

[Robert Starr:]

Thank you, Ryan.

[Operator:]

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

[Edward Marshall:]

Good morning, guys.

[Neal Keating:]

Good morning, Ed.

[Robert Starr:]

Good morning, Ed.

[Edward Marshall:]

So I wanted to talk about – I don’t know if you mentioned it earlier in the call. I jumped on late. But the ERP deployment, how is that going? Where are we? How many legs do we have left?

[Neal Keating:]

As we commented earlier, Ed, we had a major upgrade for our existing user base in the first quarter of this year and we are anticipating another major upgrade to that user base in the fourth quarter of this year. And then that will determine the final rollout plan beginning in 2017 for additional branches. But we’ve really been concentrating on bringing the acquired companies on to our network and systems and then transitioning on a very measured pace to our new Infor-based system. And so, we've got two major upgrades to our existing base this year and that will dictate the rate at which we deploy it beginning in 2017.

[Edward Marshall:]

Got it. Did you talk about the expense related with that in the fourth quarter? I’m assuming this expense is not capitalized.

[Robert Starr:]

Ed, this is Rob. A portion of that will be capitalized really depending on the nature of the outlay. So if we are incurring, which we certainly expect through the balance of the year, certain consulting costs and other costs that are not capitalizable, those will roll through the P&L. Items that are related to the software development and the system will get capitalized. We’re already incurring depreciation on that. I don't have that number right in front of me. But I want to say it’s about $1 million a quarter or so of depreciation that we’re currently taking on the system in terms of P&L impact.

[Edward Marshall:]

Got it. Capital deployment, I guess, if we talk about maybe the pipeline of acquisitions, for a while you’ve spent some time in industrial, switched to aerospace recently, is the industrial activity coming back, and specifically around maybe Parker distribution centers?

[Neal Keating:]

Ed, we remain very interested in expanding our relationship with Parker and being able to add additional Parker-authorized distributors to our lineup in Kaman Distribution. Those are relatively – takes a relatively long time to make those happen. With our acquisition of B.W. Rogers just a couple of years ago, we want to make sure that we’re demonstrating that we can fulfill the requirements of being a company that Parker can count on to grow their business. So we’d certainly like to add to that lineup. I think it's probably not going to happen in 2016, but we’d certainly like to have that on tap for 2017, if possible. That will be dictated, of course, by the seller and by Parker. And on the Aerospace side, we've done two acquisitions in the fourth quarter of last year. Very important to us. And Greg Steiner and his team are really focused on making sure that we deliver the value out of those acquisitions that we committed to our shareholders and to our Board. So we’re going to stay keenly focused on that in the Aerospace side. And in industrial distribution, we will be opportunistic. But, again, in this kind of environment, if the sellers want to have their valuation based on a multiple of earnings from two years ago or two-and-a-half years ago in a better environment, we’re not in a position that we’re going to take that risk for them.

[Edward Marshall:]

Got it. And remind me, do you have any content on the JSF?

[Neal Keating:]

We do, but it’s not a lot.

[Edward Marshall:]

Not meaningful. Okay. And would that be in the bearings group?

[Neal Keating:]

There’s a little bit in the bearings group, but it's also in our composite structures group.

[Edward Marshall:]

Got it. Thanks, guys. Appreciate it very much.

[Neal Keating:]

Okay. Thanks, Ed.

[Robert Starr:]

Thanks, Ed.

[Operator:]

Thank you. And that concludes our question-and-answer session for today. I’d like to turn the conference back over to Mr. Remington for any further remarks.

[Eric Remington:]

Thank you for joining us for today's call. We look forward to speaking with you again when we report third quarter results in October.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Have a great day, everyone.