Kaman Corporation
Q2 2015 Earnings Call Transcript

Published: 31 Jul 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Kaman Corporation Second Quarter 2015 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 be given at that time. [Operator Instructions]. As a reminder, this conference call is being recorded. I would 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 2015 conference call to discuss our earnings results. 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 this morning, please note that some of the information discussed during today's call will consist of certain 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 2014 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'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. During the second quarter we executed well in both segments and delivered adjusted EPS of $0.63 which was ahead of the prior year. Stronger profitability was primarily driven by two factors; record high operating margins of 20.5% at aerospace; and a sequential 110 basis point margin improvement in distribution. We achieved this level of profitability despite lower year-over-year sales in aerospace and being impacted by a challenging industrial marketplace in distribution. Consolidated sales were $446.3 million for the quarter, down modestly against the prior year. Before reviewing the segment level details, I would like to take just a moment to recognize our almost 5,000 dedicated employees around the world. 2015 marched the 70th anniversary of our great company and we were pleased to commemorate this milestone with our employees at a celebration last month. At that event, we were able to announce that we were resuming production of the K-MAX helicopter. The K-MAX was Charlie Kaman's last design and there couldn’t have been a more fitting day to make the announcement as we celebrated all that he accomplished during the 55 years he led our company. Restarting K-MAX production is an important step for Kaman. To-date we have orders from North American and European customers and are in late stages of negotiations to place aircraft in Asia as well. We are pleased with the initial reaction in the commercial market and expect to begin deliveries early in 2017. This program has several unique factors that we believe mitigate the program risk while providing a range of benefits. First, because the aircraft is already fully developed and FAA certified, restarting production is expected to require a limited investment. We will produce the aircraft utilizing our existing infrastructure requiring only about $1 million in capital expenditures and modest working capital investment. Further we believe a hot production line will strengthen our position with the U.S. Arm Services for the unmanned version of the aircraft. And again this summer we've all seen the danger to much of the Western U.S. from forest fires. There is ongoing interest in an optionally highlighted firefighting mission for the K-MAX and we along with our partner Lockheed Martin will be conducting a firefighting demo in the early fall in Boise, Idaho at the headquarters of the U.S. Department of the Interior, Bureau of Land Management, Office of Aviation Services.. So I believe we are off to a good start on a program with significant long-term potential for Kaman. Now, I would like to walk you through the highlights of each of our segments, beginning with aerospace. Segment sales in the quarter were $142.3 million which was down $12.6 million from the prior year with the decline primarily attributable to lower volume in our legacy missile and bomb fusing programs which were down nearly $10 million over the prior years. Sales of bearing product lines adjusted for foreign exchange impacts were up slightly while JPF and structures revenues were essentially flat. Looking further at the program level, higher AH-1Z revenues were essentially offset by lower year-over-year revenue from C-17, Bell helicopter rotor blade demand, BLACK HAWK and V-22 along with lower Egyptian SH-2 revenue. In aerospace, despite lower revenue, operating profit dollars increased approximately 9% over the prior year as margins registered a 330 basis point improvement. This improvement was primarily driven by JPF customer mix with direct commercial sales accounting for nearly two-thirds of unit volume in the quarter, and continued solid performance from our specialty bearing product lines. Bearing demand remains strong and we continue to improve our operational execution which also contributed to aerospace's quarterly results. We expect both of these product lines to continue their strong performance as we move through the back half of the year. Looking at distribution, segment level sales increased 2% to $304.1 million. Organic growth per sales day was a negative 0.8% ending six consecutive quarters of organic growth. The quarter started on a strong note registering 4.6% organic growth in April, our best monthly performance of the year. However, organic growth turned slightly negative in May with a further step down in June as our comps became more challenging. Taking a closer look at the organic growth rates by product platform, bearings and power transmission was down slightly against prior year while fluid power experienced the deepest slowdown given their industry exposures. And we were pleased that automation control and energy was up modestly against the prior year. Also it is important to note that our organic sales increased sequentially from the first to second quarter reflecting strong relative performance given the challenging industrial environment. While we were disappointed that the macro environment is not more robust, we continue to invest in growth opportunities so that we can benefit more fully when market conditions turn more favorable. Segment level adjusted operating margin was 5.3% in the quarter, slightly lower than prior year and up a 110 basis points sequentially. Distribution was impacted by slightly negative organic growth, higher ERP depreciation and pension expense along with lower vendor incentives. In summary, we were pleased with our ability to deliver improved profitability despite a more difficult revenue environment. Looking forward we see some near term challenges that are causing us to temper volume expectations for 2015. However, we are confident in our ability to control costs and drive results over the second half of the year. Now, I would like to turn it over to Rob to provide you with some additional details. Rob?

[Rob Starr:]

Thank you Neal, and good morning everyone. I would like to begin this morning by reviewing our financial performance for the second quarter. At a consolidated level, we continue to meet our segment expectations for the year delivering second quarter adjuster earnings from continuing operations of $0.63, a couple of cents ahead of the prior year. As Neal mentioned, we achieved in line [with our] expectations despite lower than expected revenue in the quarter, driven by consolidated operating margin improvement of 50 basis points over the prior year at 6.8%. During the quarter, consolidated sales were 446.3 million or about 1.5% lower than the same period in 2014. I would like to now walk through the details by segment beginning with aerospace. Segment level operating margin was the clear highlight which was up 330 basis points over the prior year to 20.5%. The aerospace team accomplished record high margins despite an 8.2% decrease in revenue to a 142.43 million, as achievements came from several factors including a reduced mix of lower margin structures program, strong proper contribution from our specialty bearing product line, a positive mix shift of Joint Programmable Fuze direct commercial sales shipment and segment level cost control. We are also seeing some of our recent new facility investments began to payoff with strong truing orders in the UK and improving performance in our German specialty bearing operation. Looking to distribution, as we noted in the prior quarter, conditions continue to be softer than expected and sales trends have remained weak into July with year-over-year organic sales down mid single-digits in the month to this point. Our end market performance has been mixed. And while we have limited direct exposure to the oil and gas sector, it has become increasingly clear that this sector's weakness has spilled over to the broader industrial economy which is impacting us. Despite of these near term challenges, we continue to invest in the business and are pursing growth opportunities and margin enhancement initiatives across the business. I would like to add a column about our reported tax rate in the quarter which was unusually low to 20.3% effective for the quarter. We recorded certain discrete items relating to a state income tax regulatory change that provided a current period benefit of about $0.16 per share but will ultimately result in higher state taxes in the future. Our future effective tax rate is expected to remain at approximately 35%. However, given these discrete items in the second quarter, our 2016 full year rate is expected to be approximately 31%. Last quarter we initiated a renewed share repurchase program and have bought back approximately 9,000 shares during the quarter. This did not have a meaningful impact on our second quarter earnings per share. Turning not to our outlook for the year. We have made a number of adjustments. Overall we are reducing our revenue expectations in both segments and our rate in the operating margin range in aerospace offset by a modest reduction in our distribution margin outlook. Starting with aerospace, we have lowered the range for revenue expectations by $20 million at the midpoint. This primarily reflects percent of several programs such as the Peru SH-2 program and missile programs, along with revised expectations for certain programs in the near term. While aerospace sales will be lower we have significantly increased our overall margin expectations due to a more favorable product mix and high profitability on certain product lines, most notably the Joint Programmable Fuze. At distribution we have lowered the midpoint of our forecasted sales range by approximately 4% or $50 million based upon our expectations for continued softness in the industrial markets through the remainder of the year. This implies a full year consolidated growth rate of 3% to 5% with an organic growth rate of negative 1% to positive 1% at distribution. We have lowered the midpoint of distribution to operating margin base up by 15 basis points to 4.9% as we look to offset the impact of lower sales through managing of expenses along with operational improvements we're undertaking in the business. These include process improvements and margin enhancement initiatives to drive of higher levels of gross profit. Our expectations for corporate expense and free cash flow remain unchanged. Similar to last year, we expect our earnings for the year to be weighted to the fourth quarter with more than one-third of our full year net earnings projected to be recorded during Q4. This is driven by the expected cadence of sales mix and accompanying operating margin contribution in aerospace. With that, I will turn it back over to Neal. Neal?

[Neal Keating:]

Thanks, Rob. I think it's clear that the first half of the year has not played out exactly as we had predicted. The industrial economy continues to be significantly weaker than anyone forecasted coming into the year and program delays in our aerospace business, primarily in our legacy missile product lines have led the lower revenues in aerospace. However, despite these top-line challenges, we have been able to deliver operating profit in line with our expectations and the investments we have made in the businesses such as our new facilities in the UK and Germany are paying dividends. In this quarter, the diversity of our three platform strategy in distribution also proved to be a strength as our automation control and energy product area helped to offset some of the weakness in fluid power. So half way through the year, I am pleased that we've met our profit expectations despite the additional program and product specific challenges we've highlighted. And while we recognize there is a lot of work ahead of us in the second half of the year, we are confident in our team and the capabilities across command to achieve these objectives. With that, I will turn the call back over to Eric. Eric?

[Eric Remington:]

Thanks Neal. Operator may we have first question please?

[Operator:]

Thank you. [Operator Instructions]. And our first questions comes from the line of Ed Marshall from Sidoti & Company. Your line is open. Please go ahead.

[Edward Marshall:]

Good morning everyone.

[Neal Keating:]

Good morning Ed.

[Rob Starr:]

Good morning Ed.

[Edward Marshall:]

I am curious when we look at the guidance and especially the tax rate, I am wondering if you anticipate, you expected to or does that include that $4.3 million tax benefit in the quarter, to me it looks it includes it but I just wanted to be clear?

[Rob Starr:]

Yes, now, Ed. Thank you for the question. This is Rob. It does include the impact of the tax change. So we just wanted people to understand what the GAAP estimated tax rate will be for the year.

[Edward Marshall:]

Got it. So on a pro forma basis, it will be close to the effective rate of 35?

[Rob Starr:]

Yes.

[Edward Marshall:]

Okay. When you look at the mix in aerospace, I know you had a pretty good quarter as it was related to commercial, and I guess that's a foreign military sale in some respect, and I know they are unusual on timing at that times. Can you look at your backlog and tell, and have an idea as to when those orders are coming through, I assume you do. And is there anything coming in the next two quarters related to the commercial sales?

[Neal Keating:]

Ed, this is Neal. You are exactly right. When we are able to book a direct commercial sale order for JPF we do have a fairly good understanding of what the shipment timing will be. As you know sometimes that vary a little bit but it is one of the drivers behind the strong profit performance that we're forecasting for the fourth quarter of this year. Again, similar to this quarter, we will have a strong mix of direct commercial sales for the JPF product line that fourth quarter.

[Edward Marshall:]

I understand it tend to ship depending upon the U.S. Air Force's request or shipments as well. Are we at that point where you have pretty good visibility that it won't shift from 4Q to 3Q or first quarter of next year?

[Neal Keating:]

There is always some variability in that because there is special transportation that's required for that as well, as well as export licenses. So there is always some variability in those respects Ed, but we think that we have that pretty well scoped out. But there is always some variability.

[Edward Marshall:]

Okay. If you quantify the decline in bearings in the industrial business, I think you might have said modestly. Do you have that number and also do you know where the inventory levels of bearings industrials, in the industrial distribution stand?

[Neal Keating:]

Okay. So on the industrial distribution side of the business, we did have a slight decline in the bearing in power transmission area, but it was relatively slight. We did experience a much more pronounced decline in fluid power which I don’t think surprises you or anybody. And overall our inventory levels have not changed very much. So we're relatively stable there.

[Edward Marshall:]

Okay, great. Thanks guys.

[Neal Keating:]

Okay. Thank you Ed.

[Rob Starr:]

Thank you Ed.

[Operator:]

Our next question comes from the line of Matt Duncan from Stephens, Inc. Your line is open. Please go ahead.

[Matt Duncan:]

Hey guys.

[Neal Keating:]

Good morning Matt.

[Rob Starr:]

Good morning Matt.

[Matt Duncan:]

So first question just on KIT, the deceleration in revenue that you're seeing here. Is there any particular customer end market you can point to that's responsible for that Neal or is it really more of a broad based slow down that you are seeing?

[Rob Starr:]

Matt, this is Rob. It's really, I mean as we look at our top 10 end markets, four were down, four were up, but the ones that were down were down fairly considerably, those mostly being mining, non-metallic minerals, aggregates, machinery manufacturing and into the wholesaler. We have seen certainly in the mining and commodity area that more of a deceleration and we were being impacted by that.

[Neal Keating:]

Matt, the other thing I would add, we tried to make sure that we hit it on our prepared remarks is that the second quarter comp for us got at pretty tough. So our organic sales were actually up from the first quarter to the second quarter but last year we, as you may remember we had a really strong both organic and acquired growth rate for KIT in the second quarter 2014. Now the comps don't get very much easier for us through the balance of the year. But we were pleased to see that the team at distribution was able to deliver positive organic growth from the first to second quarter despite as you know some really tough markets out there.

[Matt Duncan:]

Sure. So Neal on that point maybe this is for Rob. If the organic sales decline stay in the mid single-digit on a per selling day basis, and you've got four fewer selling days in the fourth quarter than you did last year, would you still be in the guidance range that you've given for that segment if we stay in the sort of down mid single-digit daily organic decline, would that put you in the guidance range or do you need things to get a little better later in the year to do that?

[Rob Starr:]

Yes, now, Matt excellent question. The implied second half our daily organic sales were, is between, negative about say 3% and up 2% but on a fewer selling days on the back half of the year. But to answer your question, yes, on an absolute basis, it can be down in a mid single-digit range and certainly meet our outlook.

[Matt Duncan:]

Okay. That’s helpful. So let me first go with aerospace then. I am trying to make sure we understand the flow in the back half in that segment because it sounds like the 4Q from both a revenue and profit perspective are going to be much higher than the 3Q to sort of get to that one-third of full year earnings is going to come in the fourth quarter the guide that you've given us. Can you help us sort of look at 3Q versus 4Q in aerospace to make sure we kind of dial this in correctly?

[Rob Starr:]

Yes, no, Matt, this is Rob. I think the way to think about it is about 30% or so of aerospace's full year sales will be the fourth quarter. But one thing to keep in mind is that Neal mentioned before is based upon expected timing of JPF shipments as well as bearing deliveries in few other areas, we do expect the margin in the fourth quarter would be higher just based on product mix.

[Matt Duncan:]

So it's really more of a product mix margin driven earnings number than it is sort of a really lumpy sales number?

[Rob Starr:]

No, it's, the sales will be weighted more towards the fourth quarter.

[Matt Duncan:]

Okay. And the last thing just on the programs that seem to be slipping a little bit Neal. Can you give us any more detail on sort of why they are slipping and when you think these things are going to start to sort of hit the ground running again?

[Neal Keating:]

Yes, for us one of the big impacts was some slippage in the Peru program, that’s really timing as we met with them, they have, wanted to add some additional capabilities to the aircraft. So that has required us to go through a second, go through a preliminary design review for a second time. So actually that would be a little bit of good news for us as we go through the program. But it is impacting us here in the near term.

[Matt Duncan:]

Okay. That helps. Thanks guys.

[Operator:]

Our next question comes from the line of Jack O'Brien from CJS Securities. Your line is open. Please go ahead.

[Jack O'Brien:]

Good morning, thanks for taking my question.

[Neal Keating:]

Good morning Jack.

[Rob Starr:]

Good morning Jack.

[Jack O'Brien:]

So despite revenue being a bit light, aerospace margins are impressive with obviously strength coming from bearings and JPF. As we put the next couple quarters aside, how can we look about EBIT performance going into 2017 or '16 excuse me?

[Rob Starr:]

Yes, Jack now this is Rob. I think certainly if you go back to Investor Day where we talked about our goal of having aerospace at high teens margin and certainly the outlook would indicate that, that we've accomplished that. As we look at clearly we're not providing any outlook for '16 at this time. But I would say that certainly our two most profitable segments have strong fundamentals behind them those being bearings and certainly our fusing and JPF programs with very solid backlog, very solid performance. So we feel pretty good about that. In aerostructures business we continue to work on the performance, that business has certainly been stable and showing good pockets of improvements. So we feel very comfortable with the business overall is in good shape.

[Jack O'Brien:]

Alright, great. And then just one quick follow up. Given the somewhat slow start to first half of the year, does this impacts you in regards to acquisitions, if you're looking to solidify them more or if doesn’t impact you at all, what you guys are seeing out there?

[Neal Keating:]

I don’t think it does Jack. We've consistently stated that we're very interested in being able to acquire companies that will build up the strength that we have in our bearing and engineered products categories within the aerospace business. And while that end market conditions or volatility certainly may impact some of the valuations distributions companies. I don’t it changes at all our long-term strategy of continuing to build out our geographic footprint and also supplementing with additional acquisitions in both the automation control and energy as well as fluid power markets. So I don’t think it changes our strategy at all. It may change the relative valuations that we might be willing to pay in the near term for some of the distribution companies. But I don’t think we've seen any change in multiples in the aerospace market.

[Jack O'Brien:]

Alright, great. Thanks Neal.

[Operator:]

Our next question comes from the lines of Ryan Cieslak from KeyBanc Capital. Your line is open.

[Ryan Cieslak:]

Hey. Good morning, guys.

[Neal Keating:]

Welcome Ryan.

[Rob Starr:]

Good morning Ryan.

[Ryan Cieslak:]

Glad to be here. I think first off Neal I wanted to maybe get some color on how the underlying pricing in distribution trended through the quarter and maybe more importantly what's implied in the updated distribution outlook for the back half of the year?

[Neal Keating:]

Actually Ryan despite some of the lower vendor incentives that we experienced in the quarter as we commented on, we had an okay pricing environment. I think a lot of that has to do with some of the process improvements that Rob referenced. We are really trying to be very disciplined around our pricing strategies. And also the team in distribution has done a good job of effectively managing their cost base given some of the declines that they've seen in the end markets. So I think it's a combination of not having a much pressure on the pricing line as we might have otherwise thought, and again I think I would give our team some credit on that, and also some product mix within the -- in particular the power transmission and motion control group with some movement towards slightly higher mix of higher profit product line sales in that -- within that platform.

[Ryan Cieslak:]

Okay, that’s great. Good color. And then I think in the prepared remarks you had mentioned some margin enhancement initiatives within distribution. I just wanted to see maybe if you can provide some more color exactly what you guys are looking at there as obviously facing a little more difficult demand environment?

[Neal Keating:]

It really comes down to pricing discipline and how we look at not only the individual line item pricing Ryan but also the cost to serve a customer. So I think a little bit better analysis for us based on frankly some tools we've put in place over the last couple of years that we're beginning to get some return on right now, enables us to better establish what our cost to serve a specific customer is. And that helps us to obviously price more effectively. And I think that, that’s come through and helped us. And also we've had some consolidation of back-office ERP systems now as we gone through the first half of the year and that's provided us some benefit as well. I mean obviously that comes through SG&A cost not the gross margin but we've seen some benefit there as well.

[Ryan Cieslak:]

Okay, great. The last question I had, I just want to take maybe another shot at thinking about the aerospace margins going forward and maybe the way I would ask it is thinking about the trajectory of those margins into 2016 and how mix might play into that just based on what you guys see within the backlog right now as I am assuming maybe there is some normalization that potentially could occur as we go into the first half of the year but maybe just some color around that would be helpful?

[Neal Keating:]

Yes Ryan it's a good question. And the reason I say that is that we look at it from several different perspectives on the aerospace side. Number is we have a really strong specialty bearing product line and that backlog continues to build, really great positions on new aircraft, the business for us with the highest percentage of after-market sales as well. So we feel really confident in the ability of that business that continue to grow, although low to mid single-digits probably but growing. They continually make improvements in their operational performance that contributes to the bottom-line. So we really feel very good about that business. The other is that as you look at our fusing product lines, we see clear underlying strength and continued exceptional operational performance in the JPF product line. So we see that continuing certainly into and hopefully through '16. And where I think we were most at to see some of the change in the margin percentage would be based on our ability to continue to grow our tooling and aerostructures businesses. We see growth there, although it has been slower than we would like. We see growth there. And we know that that will come in at lower margin performance. So it will certainly contribute to earnings which is for us what's important but that may cause some pressure on our overall margin percentage. And that's why we have talked about the target range being in the upper teens. We would like to see it be in the upper teens because of the stronger contribution of revenues from our aerostructures business.

[Ryan Cieslak:]

Okay, great. That’s all, it was a good color Neal, I appreciate it. I will get back in the queue. Thanks guys.

[Neal Keating:]

Thank you.

[Rob Starr:]

Thank you Ryan.

[Operator:]

Our next question comes from the lines of Steve Levenson from Stifel. Your line is open.

[Stephen Levenson:]

Thanks. Good morning Neal, Rob and Eric.

[Neal Keating:]

Good morning Steve.

[Rob Starr:]

Good morning Steve.

[Stephen Levenson:]

There was just a small mention of foreign exchange in the press release. Can you give us an idea of how that's really, little more detail on how it's impacting things and are there any actual opportunities for you to ship production over to the European plant a little bit or biomaterials there where you can get the damage from the dollar?

[Rob Starr:]

Good question Steve. In terms of the foreign exchange impact, we had about a $2.5 million top-line impact in the quarter. The overall profit impact was not all that considerable which is why didn’t get a lot of press. We do continue to monitor it. We do, as any company would, have positions in place to help mitigate some of that impact. We are constantly working with our European counterparts to make sure that we understand our exposures. To your second question Steve, we certainly look at opportunities to create natural hedges in terms of where we procure and looking at our cost structure. But if you were to look at our businesses, there is somewhat limited opportunity to really shift the whole lot of work from the U.S. to our international locations just given different capabilities and machining and really kind of the CapEx that would be required to do that. We view it as, we clearly look to mitigate the foreign exchange risk through whether it's financial instruments or just kind of natural offset by procuring in local currency in our foreign locations.

[Neal Keating:]

Yes Steve, we would have some additional cost to go through first article inspection and certification if we were to move some production from one plant to another. And …

[Stephen Levenson:]

Okay.

[Neal Keating:]

… and so that would probably offset the additional, the advantage we might get. So I think longer term if we look at a five year timeframe we would like to have multiple certifications for products at different plants but right now I don’t see us doing that in the near term.

[Stephen Levenson:]

Okay. Got it. Thanks. And the K-MAX question, I know that's starting to restart production and the firefighting seems like a good application. Will you be using a bucket or have you or do you plan to design an [integral tank], is that even possible with the airplane?

[Neal Keating:]

We would typically use a bucket, although we have in certain situations used a water cannon that does use, I am not actually sure if it's totally internal storage for the water retarded or if it's external bucket that they pump up from but normally for forest fires we are going to use a Bambi Bucket.

[Stephen Levenson:]

Got it. Thanks a lot.

[Rob Starr:]

Thank you Steve.

[Operator:]

Our next question comes from the line of Pete Skibitski from Drexel Hamilton. Your line is open.

[Pete Skibitski:]

Hey guys.

[Neal Keating:]

Good morning Pete.

[Rob Starr:]

Hey good morning Pete.

[Pete Skibitski:]

Hey on the aerospace guidance we got the top-line reduction of it's about 15 million to 25 million. Is it kind of 10 million in fusing shifted into 2016 and 10 million SH-2, is that kind of the right ballpark to think about?

[Rob Starr:]

Yes, Pete, this is Rob. I think certainly, I don’t think it will fall off the mark but it really comes down to a few different areas, look I mean certainly as Neal mentioned on fluid timing, I think impact, missile program is probably our most significant impact. In terms of the reduction in the outlook, we've also had some timing on a couple of commercial programs. So if you think about Bell commercial demand has been relaxed a little bit, pushing some things into '16 and as well as A330 rate reduction has also impacted us to some extent. So those would be the major contributors to the reduction in the outlook.

[Pete Skibitski:]

Okay, okay. Are you done with New Zealand at this point or is there maybe one more quarter left on that program?

[Rob Starr:]

Yes, we expect to complete the delivery of the last two aircraft during the third quarter. There will be some revenue impact there but not a lot, still I would say the vast majority of the revenue from the SH-2 New Zealand program will come to a conclusion in the third quarter with some triple-ons in the fourth quarter, maybe even a little for next year but not much.

[Pete Skibitski:]

Okay. And you booked some revenue on fluid already, is that correct?

[Neal Keating:]

Yes we did.

[Rob Starr:]

Yes we have.

[Pete Skibitski:]

Okay, okay. Last one maybe from me. Hey, Neal, do you guys see any impact to you guys from Lockhead?

[Neal Keating:]

Actually we would do that as a net positive feed. Clearly we are very large and strong supplier to Sikorsky which I think is demonstrated by how long we've worked with them on the UH-60 program and we don’t talk about it as a lot but we do an awful lot of work for them on their blades, their helicopter, rotor blades as well. So Sikorsky is a really good customer for us and we have a very strong high level relationship with Lockhead on the unmanned K-MAX program obviously. So we feel that, that overtime will be a net positive for us. We were glad to see that Lockhead was a successful bidder.

[Pete Skibitski:]

Okay. Thank you guys.

[Rob Starr:]

Thank you Pete.

[Operator:]

Our next question comes from Scott Graham from Jefferies. Your line is open.

[Scott Graham:]

Hey, good morning.

[Neal Keating:]

Good morning, Scott.

[Scott Graham:]

I wanted to ask about the tax rate again. So what you have here in your guidance is GAAP tax guidance, yes?

[Rob Starr:]

Yes, that is GAAP.

[Scott Graham:]

So it would imply sort of call it 33%, 34% second half rate?

[Rob Starr:]

That’s correct, I mean I think you can …

[Scott Graham:]

Got you.

[Rob Starr:]

… about 35% Scott yes.

[Scott Graham:]

Okay, okay. It's 35.

[Rob Starr:]

Yes, between 34 ...

[Scott Graham:]

Did you say?

[Rob Starr:]

… and 35. Yes, between 34 and …

[Scott Graham:]

Okay.

[Rob Starr:]

… 35 Scott.

[Scott Graham:]

Yes, understood. The next question is, Neal, in the past you’ve been kind enough to kind of go through some of the programs that you are working on, things in the pipeline, things that are hoped for. I was hoping you would be able to do that again for us?

[Neal Keating:]

I will give it a try. We clearly are working to gain additional presence with Boeing on the 777X program both from an engineering perspective upfront from a tooling perspective as various suppliers go into production and also to try to expand our works here beyond the fix trailing edge. So obviously focused on Boeing commercial and also increasingly with Rolls-Royce primarily for the A330neo. As you can see from our reduced outlook and as Rob commented we got hurt a little bit more on the A330 reduction in rate than we would have anticipated maybe that was a little bit a poor planning on our part, maybe it was, but it ramped down a little bit more quickly than we had anticipated. But we are working very hard and have had some success building on our relationship with Rolls-Royce on the A330. And on -- we talked a little bit about Bell helicopter again on both commercial and military are very important customer to us, they are working on the new aircraft, for them the relentless, their 525 aircraft and we've got a very strong position with them on that aircraft. So we were glad to see that have its first flight and that will be coming out I believe that they are beginning -- going to begin delivering that in late 2017. So hopefully the timing for the oil patch will be good for them. We have also built a nice position on the P8 and as that ramps up for both U.S. and foreign demand such as India that will be important to us. And we are also trying to expand into companies like [indiscernible] and others in Europe to expand our footprint. And also while it's relatively low rate we were with the 767 -- for the 767 we were glad to see Federal Express give an order for 50 aircraft, I think with options for 50 more. So if they take that rate from effective 1 to 2 that will be a plus for us and also the tanker. So I apologize for going on so long Scott but that’s kind of the breadth, I think it really speaks to the breadth of different programs that we're on today and those that we are hoping to get on.

[Scott Graham:]

No, that sounds very important, Neal, thanks. Last question and this is kind of maybe for both of you and it was I think addressed a little bit earlier. This distribution margin I know has been locked stubbornly locked in the sort of 5% area plus or minus. I was just wondering if you look at this -- at the benefits that you expect from ERP and from better operating leverage when the sales come. But in this environment it just seems like the sales are just not going to come for a while longer. I was just wondering if the environment had -- has made you look go back and maybe look at what you can do, I don’t mean little things, I mean something more draconian to permanently push this margin up a 100, 150 basis points and to do so faster than what the plan is. Just I know we're relying on operating leverage here and I know that the ERP system is going to give you some great tools to further enhance the margin. But I guess maybe over the next six to nine months, it doesn’t feel like we're going to get a lot of pop out of sales for industrial distribution overall. Just wondering if something had, if that had maybe stirred a relook at distribution?

[Neal Keating:]

Scott I don’t think it has caused us to relocate distribution. Clearly a number of the things that we are implementing right now are having an impact. I think that when we think about year-to-year impact for us on increased pension cost and ERP depreciation this year, we've said it's 30 to 40 basis points and obviously we are not getting the benefits yet of the ERP system because such a small percentage of our business is on it today. But if we look at the business going forward, we know that we will begin to get benefit of that. Also next year our pension expense will roll off and that can have between a 30 and 40 basis point impact right there. So if we were to use your 100 basis points Scott just notionally we can get not quite but almost half way there simply by the reduction is our pension expense and also this year we haven’t talked about it very much but our healthcare expenses is up pretty significantly from year-to-year as well. So what we feel is that at the top-line the mix of our businesses between bearings and power transmission with our very strong fluid power business and automation control and energy businesses that we have the right collection of products with the right margin opportunity to really meet our customers' need and be able to generate higher levels of growth. Now you are right the environment is not great but we continue to have positive organic growth from quarter-to-quarter that’s helped us. We've seen some underlying improvements in our SG&A, part of it is consolidation of systems. So we are beginning to see some of that but we're in very early stages of that. And then finally, as pension rolls off it will be a big plus for us. So I don’t it has caused us to rethink our strategy frankly at all. We need to go faster on a number of our infrastructure efforts but the strategy remains the same.

[Scott Graham:]

Okay, thanks.

[Neal Keating:]

Alright. Thank you Scott.

[Operator:]

Thank you. [Operator Instructions]. Our next question comes from the line of Rob Crystal from Goldman Sachs. Your line is open. Please go ahead.

[Rob Crystal:]

Hey guys, how are you?

[Neal Keating:]

Good Rob.

[Rob Starr:]

Hi Rob.

[Rob Crystal:]

Neal I had a question on 777X. What about the bearings piece, I don’t know whether you touched on that, maybe I missed but do you have bearings content, do you think you will have bearings content for it?

[Neal Keating:]

Yes, thanks Rob. We do and we will and hopefully a higher percentage, and Rob Patterson will talk to me sharply later today since I hadn’t mentioned that so thank you.

[Rob Crystal:]

[indiscernible]

[Neal Keating:]

Alright.

[Rob Crystal:]

In terms of bearings business, if we think about back in '08 when you last disclosed the business I think it was like a 141 million in revenue and like 50 million bucks in EBIT. Given where we are in the aerospace cycle, is it reasonable to think that if we were to see that business today that we should as substantially more profitability today in dollars than it did back in '08 recognizing you may not want to give away the exact numbers for competitive reasons but just to give as a ballpark?

[Neal Keating:]

Rob, you are absolutely right, the profit contribution in dollars is significantly higher than it was. I think your starting point for revenues might have been a little bit high.

[Rob Crystal:]

Okay. And then when we think about the cash flow this year Rob, is that a sustainable free cash flow level, if you will, from the idea of is there a working capital benefit in there or is it just more of a basic pure cash from operations minus CapEx?

[Rob Starr:]

A good question. I think the outlook would reflect in our view a fairly sustainable, level of free cash flow going forward there is not a tremendous level of working capital release in that number. We do have as we pointed out a fair amount of investment on AH-1Z program in particular if we think about our large aerostructure program and that program does continue to improve a little bit on the working capital side but we're not counting on any dramatic reduction in working capital for the rest of the year. And on the SH-2 which was another major release of inventory, we're towards the tail end of that. We certainly feel that when you look at the bearing and JPF and others that we have some very strong cash flow producers and distribution continues to improve their cash flow production. So we feel that's pretty sustainable.

[Rob Crystal:]

Okay. And then last one I might have missed this also. But on the distribution side you referenced rebates being a little bit soft in the quarter. Can you give us a sense, sort of drives towards Scott's question about the margins of that business, did that you cost you 10 basis points, 15, 20, some ballpark that we can think about, just, does it look like the performance was very strong in a very difficult environment? Thanks.

[Rob Starr:]

Yes, your first number was pretty close. It was about right let me put it that way.

[Rob Crystal:]

Okay, awesome. Thanks guys.

[Neal Keating:]

Thank you Rob.

[Rob Starr:]

Thanks Rob.

[Operator:]

We have a follow up question from the line of Pete Skibitski from Drexel Hamilton. Your line is open sir.

[Pete Skibitski:]

Hey guys, just a couple of quick follow ups. K-MAX, is there something worth mention about an Asian opportunity. If any sense of if you guys can maybe size that for us?

[Neal Keating:]

Right now it's low single-digit aircraft but it's with a country with best potential.

[Pete Skibitski:]

Okay, got it, got it. Very good level I guess.

[Neal Keating:]

Yes.

[Pete Skibitski:]

And then just last one. I think you guys had more sites going live with the new ERP system in this quarter and the third quarter. Can you give us a sense of the, any risk to guidance based on that go live scenario?

[Neal Keating:]

Pete, we are but it's a relatively small part of our business where we continue to improve every time that we have one of these smaller go lives. So I don’t think that we've really assessed that we had any it would have any impact on the guidance that we've provided.

[Pete Skibitski:]

Okay, great. Thank you.

[Rob Starr:]

Thank you, Pete.

[Operator:]

Our next follow up question comes from the line of Ryan Cieslak from KeyBanc Capital. Your line is open sir.

[Ryan Cieslak:]

Hey, guys. Just two quick follow ups if you will. Just I got a follow up on the ERP side of things. Neal, how should we be thinking about the overall level into next year, maybe just an update on that or remind us how the stages there will play out into next year on the ERP side?

[Neal Keating:]

We will have a number of relatively small segments of the business go online between now and this time next year. During the second half of next year is when we will start to accelerate with relatively large portions of the business going online. When we get together on the next call I think we will have a better -- I will have better number at my fingertips as to what percentage of our business we would expect to have on our new in-floor platform by the end of next year.

[Ryan Cieslak:]

Okay. And then the last one I have is just on this year repurchase authorization, it seems like there was some modest activity you guys had in buybacks but this quarter or in the second quarter rather just your view on maybe the approach to buyback into the back half of the year would be helpful?

[Rob Starr:]

Ryan, we bought about 90,000 shares in the second quarter and I would expect a similar rate of repurchases per quarter in the back half of the year

[Ryan Cieslak:]

Okay, thanks a lot. Thanks guys.

[Neal Keating:]

Thank you Ryan.

[Operator:]

Thank you. At this time I would like to turn the call back over to Mr. Eric Remington for any closing remarks.

[Eric Remington:]

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

[Operator:]

Thank you. Ladies and gentlemen, this does conclude the program. Thank you for participating and you may now disconnect. Everyone have a great day.