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Kaman (NYSE:KAMN)
Q2 2019 Earnings Call
Aug 01, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Hello, and welcome to the second-quarter 2019 Kaman Corp. earnings conference call. [Operator instructions] As a reminder, this call is being recorded. It is now my pleasure to introduce Vice President Investor Relations James Coogan.

James Coogan -- Vice President Investor Relations

Good morning. I'd like to welcome everyone to Kaman's second-quarter 2019 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'd like to 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 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 second-quarter 2019 results included on Form 10-Q and the current report on Form 8-K filed yesterday evening together with our earnings release. Please note that in the second quarter, we announced the sale of our distribution segment, which qualified for treatment of discontinued operations under U.S. GAAP, and as a result, the focus of today's call will be on the results of the continuing operations of the company.

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 Keating -- Chairman, President, and Chief Executive Officer

Thank you, Jamie. Good morning, everyone, and thank you for joining our second-quarter 2019 earnings call. I will begin today's call with a brief overview of the quarterly results from continuing operations and recent events before passing the call over to Rob for a more detailed discussion of our financial results and expectations for the remainder of the year. Before I begin the discussion of our results, I would like to note that we have made significant progress toward completing the sale of our distribution segment in the third quarter.

After the close of the transaction, we will be a highly focused and aerospace and engineered products company with substantial financial flexibility. We plan to increase our internal investment in innovative new technologies and solutions for our customers while pursuing complementary acquisitions of businesses that will enhance our leading market positions. We will remain disciplined in our approach to these investments, and we'll seek opportunities to return capital to shareholders as appropriate. Now I will turn to a discussion of our results for the quarter.

Second-quarter results continued the strong start we experienced in the first quarter. Sales from continuing operations increased 5% over the first quarter of 2019 to $175 million, but were down slightly when compared to the prior year. During the quarter, we delivered our 10th K-MAX aircraft, had increased sales on our JPF U.S. government contract and saw increased sales in a number of new programs, including the Sikorsky S-70i and Bell Helicopter composite blade programs.

We continue to see positive momentum across our specialty bearing and engineered products offerings and achieved record order intake during the first six months of the year. And July's order rate remained at high levels. Specifically, first half orders for our self-lube bearings and engine aftermarket components are up 9% and 4%, respectively, over last year. During the past few years, we have made considerable investments in our specialty bearings and engineered products facilities to position us to support this growth.

And just earlier this week, we announced the planned expansion of GRW, our precision bearings operation in Rimpar, Germany. Our team has successfully grown that business since we acquired the operations in 2015, and due to the forecasted continued growth, we have entered into an agreement to purchase land, where we will build a state-of-the-art facility to further increase capacity and improve operational efficiency. This investment is representative of the many we have made over the past few years, and we will continue to prioritize investments in our specialty bearings and engineered products operations to drive sustained organic growth. Moving to our joint programmable fuze program.

During the quarter, we delivered over 5,700 fuzes, bringing the total deliveries for the year to approximately 14,600 fuzes. In July, we received export approval from the U.S. government for our $324 million JPF DCS contract and expect to begin delivering product in September, which will help us meet our record delivery expectations of between 40,000 and 45,000 units for the year. We are also pleased with the improved financial and operational performance of our aerostructures programs and have recently received recognition from several of our customers, including being named the 2018 Black Hawk Supplier of the Year by Sikorsky and Best New Supplier of 2018 by Rolls-Royce.

As I noted earlier, we delivered our 10th K-MAX aircraft in April to Mountain Blade Runner. This completes delivery under lot one of our new build K-MAX aircraft program, which saw the addition of five new operators to the K-MAX fleet and raised the total number of aircraft in the active fleet to 33. In July, we opened our new customer service and delivery center, which will support both our K-MAX and SH-2G Super Seasprite customers. This facility not only consolidates a number of customer support functions under one roof, but also includes a new state-of-the-art K-MAX flight simulator.

As the commercial K-MAX fleet continues to grow, our new simulator will provide enhanced training capabilities for both our new and existing operators. As we look to the remainder of the year, the significant order activity for our specialty bearings and engineered products and the receipt of our U.S. government approvals for our JPF DCS contract, provide us confidence in the sales ramp we expect in the second half. The shift in sales mix to these higher-margin products and the improved performance from our Aerostructures business, we are anticipating higher operating margin performance in the back half of the year as well.

Our teams are well-positioned to execute on these customer requirements, and we have made the investments in our people and operations to support this growth. Now I'll turn the call over to Rob for a closer look at the numbers. Rob?

Rob Starr -- Executive Vice President and Chief Financial Officer

Thank you, Neal, and good morning, everyone. I will begin today by discussing our performance from continuing operations for the quarter and finish with an update on our revised 2019 outlook. Net sales for the second quarter decreased 2.2% to 174.7 million when compared to the prior year, resulting from the absence of 2.5 million in sales from the businesses sold in 2018 and a 1.9 million impact from unfavorable foreign currency exchange rates. Gross margin of 30.1% increased 20 basis points over the prior-year period, largely benefiting from the improved margin performance on our Aerostructures programs.

Operating income increased 3.3 million or 46% over the comparable period in the prior year. The increase in operating income was driven by a 3 million reduction in corporate expense from continuing operations, as we benefited from lower expenses in a number of areas. Aerospace operating margin improved by 140 basis points over the prior year. However, the prior-year period had approximately 1.6 million more in restructuring expenses than those incurred in the current quarter.

On an adjusted basis, aerospace operating margin was 14.2% or 50 basis points higher than the comparable period in 2018, which speaks to the underlying improvement we have seen in the operating results of the business. During the quarter, changes in Connecticut state tax law allowed us to reverse tax reserves related to the net operating losses, which we were previously unable to utilize. The benefit in the quarter from this reversal was approximately 2.1 million and led to a negative 8% tax rate for the period for our continuing operations. Diluted earnings per share of $0.23 increased $0.06 over the corresponding period in the prior year.

In the quarter, we received an $0.08 benefit from the change in state tax law and had a $0.01 impact from restructuring activities at aerospace. Adjusting for these items, diluted earnings per share was $0.16, $0.02 lower than the prior-year period. The lower adjusted diluted earnings per share was primarily due to the 2.9 million decrease in net periodic pension benefit and a higher tax rate when adjusted for the changes in state tax law, offset by the 3.3 million increase in adjusted operating income. During the second quarter, our use of cash was a result of a build in inventory for a JPF DCS and specialty bearing product lines as we prepare for the expected ramp in sales in the second half of the year, which will contribute to strong cash flow generation for the full year.

With the build in inventories in the quarter, our debt-to-cap ratio ticked up 20 basis points to 31.9%. However, with the anticipated proceeds from the sale of distribution, we expect to be in a net cash position and have significant financial flexibility to pursue our strategic objectives. Finally, as we discussed in our June announcement of the sale of Distribution, we are suspending our guidance for all aspects of our outlook with the exception of our sales and operating income for our aerospace segment for the balance of the year, and we expect to provide a consolidated outlook beginning in 2020. Based on the performance through the first half of the year, we are increasing the low end of our sales range by $10 million and now expect sales in the range of 740 million to 760 million, with operating margins at aerospace in the range of 16.7% to 17.2%.

With that, I will turn the call back over to Neal.

Neal Keating -- Chairman, President, and Chief Executive Officer

Thanks, Rob. As we look to the remainder of the year, we're focused on successfully completing the sale of distribution and beginning the next chapter as the new command, focused on opportunities across our aerospace and engineered products businesses. Before we open the line for questions, I want to thank all of our employees for their efforts every day to meet the needs of our customers and to our investors for their continued support. Now I'll turn the call back over to Jamie.

James Coogan -- Vice President Investor Relations

Operator, may we have the first question, please.

Questions & Answers:


Operator

[Operator instructions] And our first question comes from the line of Seth Seifman with JP Morgan. Your line is now open.

Mike Rednor -- J.P. Morgan -- Analyst

Hey, good morning. It's Mike Rednor on for Seth. Just a few quick ones here. Can you -- with the proceeds that are expected in Q3, can you talk through the M&A pipeline? And kind of what you're seeing on that front? And the size of these proceeds is larger than acquisitions you've done in the past.

And so maybe you can give some commentary on what you're looking at and sizing this.

Neal Keating -- Chairman, President, and Chief Executive Officer

Sure, Mike. I'd be happy to. I'd start with -- I think we've demonstrated command and ability to drive value through acquisitions. Certainly, building out in the distribution business, both the fluid power and automation platforms, positioned that business for growth, and I think helped to underscore what we thought was a very good sale price to Littlejohn for a very strong business.

Our focus to be honest, in recent months, has been on the sale of the Distribution products -- or the distribution segment, Mike. So it slowed our efforts on the aerospace side, but we're now very active there. And quite frankly, we're excited about some of the opportunities that we see out there in the market. As Rob said in his prepared comments, we're going to remain disciplined, I think, disciplined in a couple of areas.

One, in sticking to the technologies that we know today in aerospace and engineered products, but leveraging the acquisitions to enter new or adjacent markets. I think the last two acquisitions that we did, both GRW and EXTEX are excellent examples of that. The GRW acquisition introduced us really into the medical and more so industrial markets, in addition to aerospace. And EXTEX really expanded our PMA aftermarket business into the engine and APU business.

So we've been really pleased with the performance of those two acquisitions, but they enabled us to get into newer markets. So I think that those are important. The second part of the discipline is we'll maintain the financial discipline in making sure that we can get the appropriate returns for those investments. And I think your last question is a good one.

For the opportunities that meet these kind of criteria, we're well-positioned with the strong balance sheet to take a step-up in the traditional size of acquisitions that we've done. If you go back to the fourth quarter of 2015, the combined purchase price for both EXTEX and GRW were -- was about $200 million. And I think that we would certainly feel comfortable going in the one and a half to two times that level.

Mike Rednor -- J.P. Morgan -- Analyst

OK. Great. And the second one, can you give an update on the 737 impacts? And how you're thinking about any will we continue to see into 2020?

Neal Keating -- Chairman, President, and Chief Executive Officer

Yeah, another good question, Mike. We -- as you can expect, we've spent a significant amount of time reviewing this from both an operational performance in the last few quarters and then certainly in preparation for today's call after some of the recent commentary from Boeing. Currently, we have not seen any low in our orders for 737. So we're pleased with that.

We don't have a single customer for 737, as you can expect. We've got more than 50 different customers that we supply to on the 737. And so far, we haven't seen any low in orders from them. We did try to size the impact, we would say -- the low end for 2019, we would say the low end is zer0 because we're within -- we're kind of within lead time already for our third quarter.

And maybe at the top end, we could be at a $3 million impact for the year. But again, we haven't seen that low yet. And so, we can't have a lot of visibility there. I think what -- the other thing that's important to us is that on the next gen, we were very pleased with content in the low 30,000s.

So 30 to 35 per chipset. And actually, on the MAX, we're going to take that up to 40 to 45,000. So longer-term, the MAX is going to be really important for us. So the transition there will happen.

And I think the one thing I wanted to be clear on is that the zero to 3 million impact was on top line revenue, not operating profit.

Mike Rednor -- J.P. Morgan -- Analyst

All right. Thank you.

Operator

And our next question comes from the line of Pete Skibitski with Alembic Global. Your line is now open.

Pete Skibitski -- Alembic Global -- Analyst

Good morning, guys. Congrats on the export license.

Neal Keating -- Chairman, President, and Chief Executive Officer

Yeah. Thank you.

Pete Skibitski -- Alembic Global -- Analyst

So yeah, a few questions on fuzes. I thought normally, it may be in the Q, maybe I missed it, but normally, there is a split on the deliveries between kind of domestic versus international. You had a 5,700 roughly deliveries this quarter. But was that all U.S.? Or could you give us a sense of the split?

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah. No, Pete, good question. Those deliveries were predominantly USG. And we have talked earlier in the year, Pete, if you recall, that, from a delivery perspective, we expected about a 60-40 split, 60% USG, 40% DCS.

That number may change a little bit in the back half of the year, depending on production and shipment requirements. But just in terms of -- and I'll pre-empt the question you may have. But certainly, as we think about the profitability ramp that we're looking at in the back half, that is going to be driven by a good part in our DCS shipments. So if you recall, DCS is really recorded at a point in time when we ship and our USG contract for JPF is really done over time.

So we expect a predominant amount of the revenue in the back half of the year for this product line to come from DCS.

Pete Skibitski -- Alembic Global -- Analyst

Got it. OK. Yes, a couple of other questions related to that, just to drill down. Post the export approval of the big contract, is it fair to think over the next two to three years, that the mix of JPF is going to skew to DCS now?

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah. That's another good question, Pete. I would say, certainly, we would expect to see a more consistent cadence of DCS shipments as we look to fulfill that order over the next few years. A couple of things.

The order activity or the solicitation activity in a lot of our customers remains very high. But also, we're currently in discussions with the U.S. government on Options 15 and 16. And the volume range -- the indicative range is between 10 and $40,000 per option there --

Neal Keating -- Chairman, President, and Chief Executive Officer

That's units. 40,000 units.

Rob Starr -- Executive Vice President and Chief Financial Officer

Units. Yes. 10 to 40,000 units, sorry. And -- so once again, we are seeing considerable demand out of the U.S.

government as well. So we feel really encouraged about the visibility and the outlook for JPF.

Pete Skibitski -- Alembic Global -- Analyst

That's great. I'll get back to you.

Operator

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

Ryan Mills -- KeyBanc Capital Markets -- Analyst

Good morning, guys. This is Ryan Mills on for Steve. Yeah, just wanted to talk about free cash flow. I know you suspended guidance for some other metrics, given the divestiture of distribution.

But I was just hoping maybe you could provide a little bit more color on the magnitude of the free cash flow improvement you expect in the second half. And I was also wondering if you could provide the free cash generation profile of the stand-alone business and maybe talk about historical free cash flow as a percent of sales or net income.

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah. Ryan, all good questions. As we stated earlier, we have suspended our guidance, just given the volatility, and we want to kind of reassess the outlook, just given the change in the business. So what I can tell you is, aerospace is a very strong cash generator.

We certainly expect a significant improvement in cash flow in the back half of the year as we continue to ramp up our bearings and collect on a number of the sales that were made in the first half. So we do expect considerable improvement in our cash flow performance in the back half of the year. But that's really all that we're going to state at this point.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

OK. And then could you provide a color on your end market breakout for Kamatics, and maybe talk about the trends you're seeing across the different end markets there?

Neal Keating -- Chairman, President, and Chief Executive Officer

Sure. I'll start, Ryan, and Rob can chime in as well. First, we wanted to underscore that we were really pleased that we had record incoming order rates for the first six months of the year. It's been actually strong both across commercial and military.

So I think the diversity of the platforms and markets that we serve in that business is really helping us, and I think the other thing is that if you take a step back just over the last four, five years. In 2015, about -- we opened a new facility for RWG for our traditional rolling element bearings in Germany. And that was predominantly for Airbus production, but now Boeing as well. So we're seeing benefits at that facility.

We've gone through the expansions that you're well aware of here for our Kamatics self-lube bearing and flexible driveshaft businesses, and that's been ongoing, continues to be ongoing today. Last year, both the facility of our -- expansion of our Czech facility, the GRW and our EXTEX facility down in Arizona, and now the expansion of GRW that we announced just earlier this week. So it's across all of our businesses, whether it's miniature bearings in Germany, whether it's our PMA business out of Arizona or our self-lube and flexible driveshaft business here. So we're really encouraged with the incoming order rates that we're seeing there and the production capacity that we've put in place to be able to expand that business.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

OK. One more for me, and I'll hop back in the queue. How should we think about corporate costs going forward? If I assume the 15 to 20 million of annual savings following the divestiture, I get a quarterly run rate of about 9 to 10 million. Is that a good assumption? And lastly, when do you expect the normal run rate to kick in?

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah, Ryan. So as it relates to corporate, as I'm sure you can appreciate, we remain very focused on managing our discretionary expenses. In terms of the run rate, what I will say is we benefited this quarter across a number of different areas. There really wasn't one specific area, whether it be group help, insurance, consulting, legal fees.

We saw improvements year over year. In terms of the 15 to 20, I just want to be clear, that is an estimate that is really across the broader organization. So I just want to be clear what that 15 to 20 represents, and we're continuing to work to refine that estimate. So I would expect that as we get on to our 2020 guidance, we'll be able to provide a much better view as it relates to kind of a normalized corporate expense, going forward.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

Thanks for taking my questions.

Operator

[Operator instructions] Our next question comes from the line of Edward Marshall with Sidoti & Company. Your line is now open.

Edward Marshall -- Sidoti and Company -- Analyst

Hey, Neal, Rob. So I wanted to ask that you talked about, Rob, and this is just a follow-up to that previous question, the $3 million of savings that you had in corporate. You mentioned a few things group help, legal, etc. Could you talk about maybe what's temporary versus what might be permanent kind of cost savings as we move forward from that $3 million number?

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah. So I would say, Ed, the changes that we saw this quarter was kind of a combination of just kind of reduced structural costs and some really just onetime benefits relative to what we experienced last year. We are continuing to evaluate, as you appreciate, our structure. And as we touched on our June call, we've preliminarily identified 15 to 20 million of savings across the organization that we expect to be able to deliver.

And we're continuing to look at that and refine that, and we'll be providing updates as appropriate. But certainly, for the balance of this year, we're not going to be providing a specific guidance toward corporate expense. We are very vigilant right now, even more so just in terms of managing discretionary expenses as you would anticipate. So really, a combination of some things that we view as structural and some things that we view as kind of just fluctuations that you normally see quarter to quarter, year over year.

Edward Marshall -- Sidoti and Company -- Analyst

Got it. Excuse me for trying again, but is that 3 million included in that 15 to 20 million savings that you're looking to --

Rob Starr -- Executive Vice President and Chief Financial Officer

No, I mean -- Ed, no. I mean, what you're seeing there is really just a focus on expenses, but nothing that's out of the ordinary in terms of what we do. So no, there's nothing there that you can kind of try to assimilate to the 15 to 20 million.

Edward Marshall -- Sidoti and Company -- Analyst

Got it. On another question earlier you talked about the 737 MAX and the impact that it might have to you. Can you talk -- can you tell us what rate you're producing at today? Is it the 42 or the 52 rate on the MAX?

Neal Keating -- Chairman, President, and Chief Executive Officer

You know, Ed, I think that that was one of the things that I was trying to get at by outlining the number of different customers that we have on the 737 MAX program. So we would anticipate that the customers that we're supplying to, across the supply chain are probably somewhere between the 42 rate that they're at today. And the 52 rate that Boeing moved from, because, clearly, a number of suppliers have used this as an opportunity to be able to catch up from where they were. So for us to say that we're at 42, 52 or 45 really is hard, given the place we are at in the supply chain and the number of end customers we supply to.

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah. Just one other comment I would add is, Neal is absolutely right. It's hard to us to discern exactly a specific rate, given the customer base that we serve. But we feel really good relative to our earlier expectations on 737 MAX, we're in line with the minimal risk toward the back half of the year because we're within the lead time for those orders for the balance of the year.

Edward Marshall -- Sidoti and Company -- Analyst

Got it. And then if I look at the comments made about record order intake, and I understand they're in engineered products and bearings. And then I compare that to what happened in backlog, it looks like it dropped 13% year over year. Can you just give me a sense as to may be some of those orders were quicker book and ship versus maybe weakness in other parts of the business, may be structures? I appreciate that.

Neal Keating -- Chairman, President, and Chief Executive Officer

Actually, we had pretty good incoming order rates in structures. And I think that what we saw was actually -- actually, we're up in backlog for the second quarter, so.

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah, just to -- just a quite -- Ed, I think, really, what you're seeing, if you're kind of looking year over year, the largest driver in terms of the change of the backlog will be around JPF.

Edward Marshall -- Sidoti and Company -- Analyst

OK. So --

Neal Keating -- Chairman, President, and Chief Executive Officer

From the end of the year.

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah. Right. If you're looking from the end of the year, I mean, really, there are two large drivers in terms of the slight reduction in backlog. That's going to be JPF product, as well as AH-1Z.

That is offset by commercial orders from Boeing for both the Wing-to-Body Fairing, 777, 767 and then it's really kind of a lots of, I hate to use this term, cats and dogs, but there's a lot of other accounts that are kind of offsetting each other. So that's why you're seeing roughly about a 1% reduction year to date in backlog.

Edward Marshall -- Sidoti and Company -- Analyst

Right. I was comparing it to 2Q last year, but that's OK. We can follow up.

Rob Starr -- Executive Vice President and Chief Financial Officer

The JPF is really going to be our largest. You can see, we've got that 324 million order in the first quarter last year.

Edward Marshall -- Sidoti and Company -- Analyst

Got it. Got it. OK. Guys, thanks very much appreciate it.

Operator

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

Chris Dankert -- Longbow Research -- Analyst

Good morning guys. Thanks for taking my question. I guess, just -- can we get any update on the SH-2? Just kind of remind us, again, what's the operating fleet look like. Any new updates as far as customers or contracts there to talk about?

Neal Keating -- Chairman, President, and Chief Executive Officer

Chris, we -- as you know, we're just completing the SH-2 upgrade for Peru. We'll anticipate shipping the last of those aircraft, likely in the third quarter of this year. And earlier -- and in an earlier call, we talked about a significant upgrade program that we're currently working on with Egypt. So we don't have that contract yet, but we continue to work toward it.

They have 10 or 11 aircraft in their fleet. Last time we did an upgrade for them, it was a $85 million program. So we see some good opportunities with Egypt in the near term for the SH-2. And then clearly, adding four into the flying fleet with Peru is going to help from a longer-term service and support annuity as well.

Chris Dankert -- Longbow Research -- Analyst

Got it. Yes, that's helpful. And then just any update as far as A350? No changes there. Are you still ramping exactly as planned?

Neal Keating -- Chairman, President, and Chief Executive Officer

Yeah, we feel pretty good about A350. We feel very good about our Airbus business overall, and A350 has certainly been a nice platform for us. We've talked a lot about the strong content that we have on that aircraft. So now as they've gotten to higher rates of production, it's been certainly helpful for us.

Chris Dankert -- Longbow Research -- Analyst

Yeah. I mean, commercial aero for the whole quarter, I assume, was up fairly nicely.

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah. No, we had a pretty good quarter on the commercial side, just given the timing of shipments.

Chris Dankert -- Longbow Research -- Analyst

Yeah. Yeah. Just last one for me. I mean, obviously, very exciting news on the new helicopter facility.

Just any news as far as bidding, interest on commercial K-MAX? Any color there would be helpful.

Neal Keating -- Chairman, President, and Chief Executive Officer

Yeah, we -- thanks for that question. We have a very active pipeline of commercial customers for the K-MAX right now. And what's interesting is that we were really happy that, of the first 10 aircraft from the lot one production, five went to new customers. So we were really excited about that.

We've got a lot of activity within that group right now. And also we actually have another follow-up visit from the Marine Corps scheduled for early next week.

Chris Dankert -- Longbow Research -- Analyst

Exciting stuff. Thanks, guys.

Operator

And our next question comes from the line of Pete Skibitski with Alembic Global. Your line is now open.

Pete Skibitski -- Alembic Global -- Analyst

Just one follow-up guys on -- question on seasonality. Last year, you had a pretty big dip, I believe, in revenue in the third quarter before it came back up pretty sharply in the fourth quarter. I want to ask, do you expect that same seasonality this year? Or with the export approval, are we going to see more of a linear ramp sequentially for the balance of the year?

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah, Pete. Really good question. I think from a sales cadence perspective, we do expect the third quarter to continue the sequential improvement that we have seen between Q1 and Q2. And really, a pretty significant ramp in Q4.

And that's really going to be driven largely by bearings and our engineered products. We're expecting to see also some relative ramp as well in our precision products, most notably, JPF in the fourth quarter. But certainly, we expect to see sequential improvement as we move through the balance of the year.

Pete Skibitski -- Alembic Global -- Analyst

Very helpful. Thanks, guys.

Operator

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

Ryan Mills -- KeyBanc Capital Markets -- Analyst

Yeah, just a couple more follow-ups. I want to talk about the level of inflation you're seeing in the stand-alone business. And maybe provide your COGS exposure to China. And I'm also kind of curious, contracts you have with the government.

Does it allow you to pass through rising costs?

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah, a couple of things there, Ryan. I'll start with your last question. The majority of our contracts are from fixed pricing. So what we typically do to offset that risk is we enter into long-term agreements with our suppliers so that we have a very good fence.

And as you would appreciate, we typically build in a level of escalation into our contracts to protect us. But certainly, if there is tariffs and other things, there are provisions typically in our contract for unusual or extraordinary costs that we typically can negotiate with our customers. So we do have some exposure, clearly, but we've taken contractual measures to mitigate that as best possible. As it relates to COGS coming out of China, certainly, like many other manufacturers, we evaluate opportunities.

But I don't think we have any real significant risk as it relates to the trade issues that we're seeing with China and how that would impact. A lot of our materials, especially on our bearings side are very prescribed alloys and other special materials that really are not going to be impacted by what you're seeing on that -- in the press.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

OK. And then can you maybe talk a little bit more about your decision to expand in Germany and maybe talk about demand trends in Europe, given weaker macro data and Brexit concerns?

Neal Keating -- Chairman, President, and Chief Executive Officer

Certainly, we've all seen some of the impacts of the slowdown in Europe overall, whether it's Brexit, whether it's their -- the correlation that they have to the ongoing issues with China. But what -- I would say it two ways. One is that we've had very good strong growth in recent years in GRW. And we are investing for and preparing for the expected continued growth there.

We may have a little bit of a low in the industrial part of their business. But certainly, when you look at the diversity of their business across aerospace, medical and industrial, we feel really good about the ongoing opportunity to grow that business. And that's why we continue to invest.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

Appreciate the color there. And then my last question just around M&A. Have you seen multiples come down in what appears to be a slower demand environment? And can you maybe talk about where margin accretive or free cash flow accretion ranks in your priorities? And then is there any business units or service offerings you want to complement more so than others?

Rob Starr -- Executive Vice President and Chief Financial Officer

Yeah, a couple of things, Ryan. I mean, depending on the asset and the unique nature of an asset purchase multiples still remain very competitive. And certainly, we have not seen any notable decrease in purchase multiples because the types of assets, the engineered product assets that we're looking for are certainly very desired across a number of different potential bidders. So we are definitely seeing a competitive landscape.

In terms of financial metrics, as Neal mentioned, we're going to be very disciplined in terms of how we look at deploying that capital toward acquisitions. I mean, there is, clearly, a strategic aspect to it, but on the financial side, certainly, as we look at internal rates of return, that will be a primary metric for us, GAAP -- EPS accretion, while important, is really dictated largely by accounting measures, and it doesn't really reflect the underlying economics and the strategic reason why you would do a transaction. But we're certainly going to be very -- cash accretion, we certainly expect, given the state of our balance sheet, that virtually any transaction that we look at is going to be cash accretive to the company. So that's great, but we're going to be very disciplined as we deploy the capital.

And then you asked one other question, in terms of what markets might we look at, in terms of complementary. I think, as Neal alluded to, GRW and EXTEX, the most recent acquisitions we've done on our engineered products side, really provide a terrific road map. Those transactions have been extremely successful for us and really provide a great road map for us as we're continuing to look at opportunities on how to deploy the proceeds.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

Thank you.

Operator

And I'm showing no further questions at this time. So with that said, I'll turn the call back over to vice president of investor relations, James Coogan, for closing remarks.

James Coogan -- Vice President Investor Relations

Thank you, everyone, for joining us on today's call, and we look forward to speaking with you again when we report our results for the third quarter.

Operator

[Operator signoff]

Duration: 41 minutes

Call participants:

James Coogan -- Vice President Investor Relations

Neal Keating -- Chairman, President, and Chief Executive Officer

Rob Starr -- Executive Vice President and Chief Financial Officer

Mike Rednor -- J.P. Morgan -- Analyst

Pete Skibitski -- Alembic Global -- Analyst

Ryan Mills -- KeyBanc Capital Markets -- Analyst

Edward Marshall -- Sidoti and Company -- Analyst

Chris Dankert -- Longbow Research -- Analyst

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