Kaman Corp (KAMN) 2007 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2007 Kaman Corporation earnings conference call. My name is Antoine, and I will be your operator for today. At this time, all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Russ Jones of Kaman Corporation. Please proceed, sir.

Thank you, Antoine. Good morning, everyone. This is Russ Jones with Kaman Corporation, and I would like to welcome to you the company's first quarter 2007 conference call. The call is also being webcast over the internet at www.kaman.com, and an online archive of this broadcast will be available within one hour of the conclusion of the call, and will be available through May 11th at this site. Conducting the call today are Paul Kuhn, Chairman, President and CEO; and Bob Garneau, Executive Vice President and Chief Financial Officer.

Before we begin, let me take a moment to reference the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. This conference call may contain certain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the company. Although the company believes that the expectation reflected in its forward-looking statements are reasonable, we can give no assurance that such expectations or any of these forward-looking statements will prove to be correct. Important risk factors that can cause actual results to differ materially from those reflected in the company's forward-looking statements are included in our earnings release filed yesterday and in the company's filings with the Securities and Exchange Commission.

In addition, the information contained in this conference call is accurate only on the date discussed. Investors should not assume that the statements made in this conference call remain operative at a later time. The company undertakes no obligation to update any information discussed on the call, and finally, our discussion today will include certain non-GAAP measures related to company performance. Reconciliation of this information is provided in exhibits to this call and is available through the webcast section on our website. With that, please turn to Exhibit 1 and we will turn the call over to Paul Kuhn. Paul.

Thank you, Russ. Good morning, everyone. Welcome to our conference call for the first quarter of 2007. Let me begin by saying that we are very pleased with our first quarter results, which reflect a continued progress across all of our business segments. Yesterday, Kaman Corporation reported that net sales for the first quarter of 2007 rose 7% over the first quarter of 2006 to a total of $317.3 million. The company also reported net earnings for the first quarter of $10.1 million or $0.41 per share diluted, up 70% from the $5.9 million or $0.24 per share diluted reported in the first quarter of 2006. Driving the gains was our strong performance in the Aerospace segment. Industrial Distribution saw some softness, but reported results that were relatively in line with a year ago, when you back out a one-time gain in that segment last year. For the music segment, we achieved higher profitability, despite slightly lower sales and less than robust economic conditions in the music markets. Results for both the first quarter of 2007 and the first quarter of 2006 each include a $2.5 million pretax charge for our Australian helicopter program, and I will talk about that in a minute.

You may have noticed a new format for our reporting this quarter as our press release is now a summary view of the quarter that complements the detailed management discussion and analysis and disclosures found in the company's 10-Q. Both documents are filed on the same day and are readily available. There's a lot of financial detail in both of these that Bob will review later in the call. Before he does that, if you would return to Exhibit 2, I will highlight the segment results. Clearly, the progress we have been making in the Aerospace segment continued in the quarter. Revenues rose 26.5%, and operating income was up 66.1% over the first quarter last year. Sales for Aerostructures grew 48.8% over the previous year quarter.

Driving this growth is the continued improvement we have been able to generate at both our Jacksonville metals oriented facility and our Wichita composites oriented facility. In Jacksonville, our three major programs involving the Sikorsky Blackhawk helicopter, the Boeing 777 commercial airliner and the C-17 military transport all continued to perform well. We delivered 20 Blackhawk cockpits during the quarter, compared to 12 during the first quarter last year, and this brings our total output to 92 cockpits from the inception of the program through the end of the quarter. Orders to date from Sikorsky total 286 cockpits, so this has become a good long-term program for the company. We have also been making higher shipments to Boeing on the 777 program. Based on their increased production of this aircraft, now averaging seven ship sets per month. The C-17 program has been an excellent long-term program in the business base, and this work is now scheduled to continue at least into the early months of 2009. In Wichita, our base business is continuing to do well in the current strong environment and new programs we have been bringing online are expected to good contributors. Both the Jacksonville and Wichita facilities continue to have capacity for additional programs, and have demonstrated the ability to complete effectively in their markets. So we are encouraged by what we have been able to achieve for this business.

Meanwhile, the commercial aircraft and the military helicopter markets that we are focused in remain quite favorable. This could become one of the longer up cycles that we have experienced. Net sales within our Fuzing division were down slightly, 2.8% compared to last year's first quarter, and to repeat what I've said in the past, this division will tend to provide some lumpy performance on a quarter-by-quarter basis. We continue to work on a variety of issues related to the company's joint programmable Fuze program at our Dayron facility in Orlando. And generally, we are very pleased with our progress in diagnosing and correcting technical issues, strengthening the reliability of the supply chain and improving material flow in order to meet production requirements. These initiatives should allow us to achieve the planned increases in production rates going forward.

U.S. government JPF orders received through the end of the first quarter totaled $116.6 million and now cover production through the end of 2008. As the JPF program continues to develop, we are increasing our focus on marketing the product to foreign allied militaries and are beginning to see early progress in that effort. Net sales in the Helicopters division grew 51.8% for the quarter. Both our deep hole level maintenance and upgrade program for our Egyptian SH-2G helicopters, which have served very successfully with Egypt since the mid 1990s, and our Sikorsky Blackhawk program, involving fuselage joining and installation work, contributed to the increase.

During the quarter, we took a $2.5 million charge on our Australian SH-2G helicopter program. This is the same amount taken in the first quarter of 2006 and represents the additional cost we expect to incur to the point of completion. There's an extensive commentary on this program in the first quarter 10-Q filed with the SEC yesterday afternoon and in each of our quarterly filings over the past several years. I know most of you have a good familiarity with a history this program, but I will take a minute to update you as to where things stand at this point. As I said to our shareholders at our annual meeting, we are in the final, final stages of completing our original contract requirements. Only a few tests remain on our formal qualification testing for the ITAS system software, and this work should conclude by mid 2007, at which time we believe that the aircraft will have satisfied the requirements of the production contract. The flight safety issues that arose last year from an anomalous signal attributed to an aircraft air speed indicator have been successfully resolved. The aircraft are ready to return to the air. We continue to work with the Australian government to address changes in their aircraft certification requirements that are not covered by our original contract. A $37.5 million contract proposal has been submitted to the government for this scope change, which involves modifications to software and hardware that could extend over a 29 month timeframe, should the customer decide that in their view these modifications are actually necessary.

Meanwhile, the company continues to wait for the Australian government's decision regarding the possibility of an alternative to the Seasprite program. While we had expected a decision by this time, we don't believe a final decision has been made. Meanwhile, the program is receiving a lot of attention in the Australian press, and by both parties within the government. And we have seen indications in the Australian press that a final decision might be deferred until later in the year. Once we have been informed of the decision, we will file an 8-K with the SEC to inform you. Right now, we continue to work with the customer and we, along with many of our Australian teammates, continue to believe that this aircraft represents the best solution for the Australian Navy's needs.

Moving along to our Kamatics and RWG airframe bearing business, the first quarter of 2007 set another record with a 22.2% sales increase over the first quarter of 2006. In fact, sales, shipments and backlogs were all at record levels for the quarter and conditions remain strong in the markets we serve. Our products are well regarded as leaders at the highest end of the market. In addition, as we reported last quarter, we are benefiting from our growing reputation as a leader in providing shorter lead times for product delivery, compared to many of our peers. We have added capacity and we are working towards further penetration for both domestic and foreign markets. So I would like to think that we could stay on an upward path for sometime to come.

For the Industrial Distribution segment, economic conditions have moderated but remain in positive territory. Net sales increased only a modest 1.7% in the quarter, but reached a first quarter record of $173.4 million. The sales increase was not sufficient to cover normal increases and operating costs, however, and operating income was down for the quarter. Bob will review that with you when he goes over the GAAP reconciliation chart as the first quarter of 2006 included a one-time gain. Performance for this segment generally reflects what is going on in the larger economy, and we do follow industrial production trends in the United States. This past quarter, branches serving customers in mining and processing industries have provided raw materials for metal making and chemicals for export, remains strong as did those serving the oil and the gas industry. Food processing was also a well-performing sector. Power generation remains stable. Branches serving industries in the housing sector, such as gypsum products, roofing tiles and the like, did less well in the quarter, as did those serving the machine building industry.

Over the past several years, there has been an increase in the number of companies in our potential customer base moving to national account contracts. There are really only a few top tiered distributors in our market, including Kaman, having the national branch network and capacity to serve these accounts. And this is leading to market shared growth opportunities at the expense of the smaller players. We had reported on two national account wins in the fourth quarter of 2006, and we have been advised that we were selected as the winner of two additional competitions in the first quarter of 2007. We incurred some initial expense to install these accounts during the quarter, and expect to begin realizing sales from them in the months ahead. Two of these four wins are expected to develop into very significant accounts for us.

The Music segment experienced slow market conditions in the quarter. Sales for the segment were down 3.1% compared to the first quarter of 2006. This was primarily the result of a weaker than expected holiday season last fall, and the inventory overhangs our customers needed to work off in the first quarter of this year. While an unstable housing market and a return to higher gas prices continue to influence discretionary spending during the first quarter of 2007, Music Trades Magazine reports an improvement in retail musical instrument sales during the quarter. At this point, it's still early to get a good read on what this means for the months ahead, including the all important 2007 holiday selling season. We have worked hard to increase our returns in this business and have made good progress. Music segment operating income was up 24.9% for the quarter, due to the benefit of our earlier Musicorp consolidation activities and ongoing segment-wide cost control initiatives.

Summing up, the first quarter represented a good start to 2007. Our Aerospace segment continued on its upward track, benefiting from both industry trends and our growing reputation as a premier quality supplier. Our Industrial Distribution segment continued to build its rep presence with successful national account competitions that indicate that the market is recognizing the value we bring to the table. Music generated higher earnings on lower sales in the slower consumer market. It is in a good position to benefit when the market for musical instruments improves. Financially, we are well capitalized, well diversified and have a strong business platform for growth. With that, I will turn the call over to Bob who will review our financial results. Bob?

Thanks, Paul. If you would turn to Exhibit 3. Let me start with a review of our GAAP reconciliations for the first quarter of 2007 and 2006. Compared to certain past periods during the realignment of Aerospace and the recapitalization of 205, the reconciliation is pretty simple. Starting at the top, we have entered the earnings as reported which include earnings before income taxes of $16 million. Net earnings of $10.1 million, and net earnings per share diluted of $0.41 in the first quarter of 2007, compared to earnings before income taxes of $10.1 million, net earnings of $5.9 million and earnings per share diluted of $0.24 in the first quarter of 2006, an increase in net earnings of 70.2% over the earlier quarter. Moving down through the columns, for the first quarter of 2007, we took a $2.5 million pretax charge, adding to the loss reserve for our helicopter program with Australia, and we incurred a minimal $200,000 in deductible and non-deductible stock appreciation rights expense. Without these items, we had earnings before income taxes of $18.7 million, net earnings of $11.7 million and net earnings per share diluted of $0.47, versus the $0.41 reported.

Moving over to the right-hand columns. For the first quarter of 2006, we also took a $2.5 million charge to the Australian program, and had a $1.3 million in deductible and non-deductible stock appreciation rights expense. Finally, we had a $1.6 million gain from the capitalization of freight into inventory in our Industrial Distribution segment. Without these items, we had first quarter 2006 earnings before income taxes of $12.3 million, net earnings of $7.5 million, and net earnings per share diluted of $0.31 for a 2007 over 2006 first quarter growth in net earnings of 56.7%.

If you would now turn to Exhibit 4, I will go briefly over segment performance. As I go over the segment operating income and operating margins on this exhibit, please bear in mind that these are before the allocation of corporate expense back to the segments. Net sales in the Aerospace segment were $93.1 million in the first quarter of 2007, up 26.5% from $73.6 million in the first quarter of 2006, as Paul had reported. Operating income was up 66.1% to $16.6 million from $10 million in the year earlier quarter. And operating margins were 17.8%, compared to 13.6% in the first quarter of 2006, both years reflecting the charges taken for the Australian program.

We do not break out the operating income for each of our Aerospace businesses, but I can tell you that the increase in operating income for the quarter is primarily due to higher sales volume at Aerostructures and Kamatics. The Aerospace segment represented 29.3% of total consolidated sales in the quarter. Our Industrial Distribution segment, net sales rose just a small amount for the quarter, 1.7% to $173.4 million, compared to $170.6 million in the first quarter of last year. Segment operating income was $8.7 million in the first quarter of 2007, from $10.8 million in the first quarter of 2006. The largest factor in the decrease was the $1.6 million one-time benefit in last year's first quarter that was not repeated in 2007. Apart from that, the sales increase was too small to fully cover the normal incremental operating costs incurred and the combination of factors took operating margins to 5% in the first quarter of 2007, compared to the 6.3% in the first quarter of 2006. The Industrial Distribution segment contributed 54.7% of consolidated sales for the quarter. Music segment sales declined 3.1% in the first quarter to $50.8 million, compared to $52.4 million in the first quarter of last year, due to a continuing soft market. Segment operating income, on the other hand, was up 24.9% in the first quarter of 2007, and operating margins were 3.1%, compared to 2.4% in the year earlier period, as a result of effective cost control programs and the elimination of redundant expenses at Musicorp, including the first quarter closing of Musicorp's Dallas warehouse. The music segment represents 16% of consolidated sales in the quarter.

If you would now turn to Exhibit 5, we have a table that we also include in the earnings release that provides some insight into the corporate expense for the quarter. Elements of the expense that do not tend to fluctuate a great deal are given in the top line labeled Corporate Expenses Before Breakout Items. Portions subject to periodic fluctuations or that are more difficult to predict are presented as breakout items. Most of these items are discussed in the MD&A section of the 10-Q. Among the breakout items from the top, stock appreciation rights expense has dropped to a small number, about $200,000 for the quarter. But we include them in the breakout because they represented a large portion of the corporate expenses in both 2005 and 2006, and we thought it would be useful to show their diminished impact. No new rights have been granted since 2003. Most of those that had existed have been exercised, and therefore should not be much of a factor in the future.

Moving down through the list, pension expense shown on this table is the amount of the total pension expense of the company that is retained by corporate. From a cash standpoint, we expect that we will be contributing $10 million to the plan for this calendar year. Our supplemental employee retirement plan is running at about the same level as last year. Group insurance was up considerably in 2007, due to adverse claim results for this period. Turning, finally to Exhibit 6, we have provided highlights in the balance sheet along with capital expenditures and depreciation. Notes payable and long-term debt outstanding were $90.9 million at the end of the first quarter of 2007, not materially higher than at the end of 2006. Shareholders equity has grown normally, principally through the growth of retained earnings. Our debt-to-capitalization ratio remains moderate at 22.9%, and that provides considerable room to fund initiatives through our $200 million revolving credit facility. We generally like to keep our capital expenditures in balance with our depreciation and amortization, but this year have budgeted increase of a few million to deal with growth in the business. If we conclude negotiations for purchase of the Bloomfield and [IROC] facility this year for the Helicopters division, the amount could go higher and we will report on that at a future time if it occurs. For a final point that might be helpful, the effective tax rate for the first quarter of 2007 was 37.2%. While the adoption of FIN 48 may lead to greater volatility in the tax rate by quarter, we do anticipate that the overall tax rate for 2007 will remain below the 39.2% level of 2006.

That concludes the financial discussion. And so in summary, the first quarter of 2007 represented another good building block along the way with good performance from our realigned Aerospace segment and positive performance at both Industrial Distribution, where we continue to add important new accounts and Music, where we have improved margins despite a somewhat soft sales environment. Let me conclude by saying Kaman is in good financial condition and has access to the resources that we need to move forward with our strategies. With that, I will turn the call back to Russ. Russ?

Well, thanks, Bob. That wraps up our prepared remarks and we will now open the line for questions. So, operator, may we have the first question, please?

(OPERATOR INSTRUCTIONS) Please hold for your first question. Your first question comes from the line of Robert Kirkpatrick with Cardinal Capital. Please proceed, sir.

Good morning, gentlemen and congratulations to everybody at Kaman on a fine quarter.

Thank you, Rob.

Could you provide us with a little bit of further color on how much capacity, either dollars or percent of the facility, both exist at Jacksonville and Wichita? You made reference in your remarks to there being substantial capacity that you could use to grow into and I would like to be able to get a quantification of it.

Rob, I don't think we are 50% utilized down there from the standpoint of available additional shifts and available floor space and expandable floor space. I really don't see capacity as a constraint in either one of those businesses going forward.

Okay. And then the extra CapEx that Bob referred to in his remarks, what will that be driven towards? It's obviously not going to be in Aerostructures and probably won't be in Kamatics, because you just finished that. Where will that go?

Two things, one is as we ramp up and production does increase, we do add machinery and equipment as necessary. Some of it is that. The other point I made was that if we do reach a settlement with the government on the purchase of the [IROC] facility, that would be an additional expenditure. Again, our goal is to retain the depreciation and amortization and the CapEx and sort of a balanced type thing. So, again, the extra expenses that we might have beyond the building needs are just for machinery and equipment.

And then, Bob, while I have you, you had a big increase that you broke out on group insurance claims.

Yes.

Does Kaman self-insure and if so, what drove the large sudden increase in claims?

We self-insure to a point. I mean, we do have deductibles that are large, as is typical of a company our size, but beyond that it was just adverse claim experience. I mean, we can't point to any specific thing, so I can't tell you something happened in California or something happened in New York or any one particular plan. It was just a group of claims that came through that were above what they typically would be.

Okay. And then Paul, you make reference in the 10-Q of the sale of a Fuze line, back to the original owners of Dayron. Could you please provide us with a little bit of commentary about that and why you have chosen to do that and what's involved?

One of the lines that we have, we are actually a subcontractor to a small business, and that happened to be the original company that we had bought Dayron from. Through discussions with him, he made an offer to us to acquire that particular line, which he felt that it was important for him from a competitive standpoint and being a small business to have. We didn't see it as being core to our Fuze business, in fact, we think the line that it -- product that it represents is really on a slowly deteriorating path. So we don't feel that it's that significant from a go-forward sales opportunity for us. So the deal was good for us. It was good for him, and it takes place after our 2007 --

The end of this year.

After we complete our 2007 requirements.

And does that also free up capacity for you to be able to produce more of the other Fuzes there or are you actually selling physical plant as well?

No, but we are -- there's a lot of equipment associated with that line and we will be leasing that piece of the facility -- rope it off and protect us from activity on that side. But until such time that they would actually move that -- and we're still negotiating as to when that would happen. We don't need that floor space without that line in anywhere near term basis so it's not an issue for us.

And then a final question for you, Paul, one that's near and dear to everyone's heart. Where do we stand on the transition for Chief Executive Officer?

We are still relatively early in the cycle. Our consultant has been very active in getting out into the industries. In fact, we have been looking at all of the industries that we have businesses in to see where the really good potential candidates are, and they have done a very long list of phone and personal interviews and are beginning now to come back to us with write-ups on candidates. I would imagine that within the next 30 days, we'll begin our interviewing process of those candidates.

Thank you so much.

Thank you.

(OPERATOR INSTRUCTIONS) Please hold for your next question. Your next question comes from the line of Arnie Ursaner with CJS Securities. Please proceed.

Hi, Arnie.

I think I will start with a follow-up to one of Rob's questions if I may, on the group insurance adverse claim issue, obviously it's an uncertainty -- but sitting here today, do you expect to have levels similar to Q1 for the balance of the year?

We would expect that it would get back to normal. We collect a premium that's designed to cover expenses. Between us and our carrier who have exacting methods for determining what we should be expensing, it is abnormally high. So we think it will come back in line.

The second is on the industrial Toronto business. You mentioned the four wins, including two that could be quite material over time. Normally when you start up a ramp up business with a new customer, you incur start-up expenses. I know you mentioned you had some. Could you attempt to quantify how that may have impacted your margin in the current quarter? And then I have a follow-up to that.

We incur certain costs, some of which are costs that we actually spend money for, some of which are people getting ready to take over accounts. And there was some costs involved in that and I don't know that it's enough to have a meaningful impact on the margin. I mean, again, some of it is soft dollars and some of it is hard, and it was there, and that will start to be taken over as the sales come in. It will be covered as the sales come in. But I don't want to sit here and say that it had a meaningful impact on the margin.

Asking the question in a slightly different manner -- when these four contracts are up and running, will the margins on those be similar to or higher than your existing base of business?

Well, they should be similar to and in some cases, depending on the size of the account -- and a couple of them are sizable, they could -- well, they will blend in with the rest of our business.

Okay. Next question I have is in the Helicopter piece of your Aerospace business, most of the numbers you had were pretty similar to the ones I had. That one caught my eye with a more substantial sequential decline than I had certainly modeled. I'm excluding the K-MAX obviously from that, but what would have caused the sequential decline of the magnitude we saw in Q1 versus Q4? Is there perhaps an explanation for that?

One of the pieces of the Helicopter business that's hard for us, even here to forecast, is the inflow of after-market support products. And we did have an abnormal amount that occurred in the fourth quarter of last year. What I think typically happens is that because we deal with foreign governments -- and it's the same with our own government as well. Towards the end of a budget period, if there's additional money laying around, they look for places to spend it. We got something in the vicinity of $5 million or $6 million worth of orders on SH-2 components that occurred in the fourth quarter. That would not normally be repeating quarterly activity, but be more spread across the year.

Got it. In terms of the overall restructuring, Paul, I know you put an incredible amount of time and effort and even some money into getting rid of the voting shares and the structure you inherited. And a couple of questions related to external activities. One is, can you identify or give us a sense of you cost basis in both the Music and Industrial segment, just in case either one of those were to be sale candidates? What sort of -- what are we looking at as far as a cost basis for those segments?

Are you talking about a tax cost or a book cost?

I guess I'm starting with your --

A book basis.

Yes.

I guess where I would send you on that. If you look at the annual report and you look at the total assets by segment and then just figure from that you would take out accounts accounts payable and you can look at the balance sheet. You can come up with at least a reasonable sense of what those book balances are.

Okay. I know at year-end you increased your borrowing capacity by an incremental $50 million. Obviously there's a lot of cash and financing available. Other than the general availability, were there specific reasons you would have increased it when you did? Again, we haven't seen any acquisition or divestiture activity since you have gotten through the restructuring of your voting shares.

Arnie, I will take that one. And there are differences during the period of the year and how much we're borrowing. And we'd like to keep a certain amount of cushion so we don't get too close to that. That was motivated first by keeping enough cushion there to take care of the normal treasury needs and also to take care of a very favorable banking market at that time. It was easy to do at a very low cost and it just provides us more flexibility.

Just, again, a follow-up to Rob. The business you are selling back to Dayron, that's in Ordnance, not in Missiles which is what's really driving the Fuzing business on a go-forward basis.

That's correct.

Thank you.

There are no further questions at this time. I would now like to turn the call over to management for closing remarks.

Well, thank you, therefore, for joining us today. We look forward to speaking with you again in the future. Thank you.

Thank you for participating in today's conference. This concludes the presentation. You may now disconnect. Good day.