Kaman Corp (KAMN) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Kaman Corporation fourth quarter 2009 earnings call. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions)

I would now like to turn the call over to your host for today's call, Mr. Eric Remington, Vice President of Investor Relations. You may proceed, sir.

Thank you and good morning, everyone. I would like to welcome you to the Kaman Corporation, 2009 fourth-quarter conference call to discuss our earnings results and our outlook for the upcoming year. Conducting the call today are Neal Keating, Chairman, President and Chief Executive Officer, and Bill Denninger, Senior Vice President and Chief Financial Officer.

Before we begin this morning, please be advised that this call may contain certain forward-looking statements such as 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 any forward-looking statements made due to several important factors described in the Company's latest filings with the Securities and Exchange Commission.

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

Thanks, Eric, and good morning. 2009 was a challenging year for many of our businesses. However, through a series of actions taken during the year, we were able to improve our performance, strengthen our balance sheet, and position the Company for long-term growth. We implemented initiatives to reduce our cost structure, which enabled us to improve our distribution operating margins sequentially as we moved through the year. We also successfully renegotiated our revolving credit facility and improved our working capital management, which combined with our cost structure efforts allowed us to generate almost $57 million in free cash flow, compared to a use of approximately $30 million in 2008.

We also achieved several important business milestones, including signing a new contract with Bell Helicopters, renegotiating and expanding our Joint Programmable Fuze contract with the US Government, and being awarded a contract by the US Marine Corps for a demonstration of the unmanned K-MAX helicopter. While these actions improved our performance during 2009, we are still facing the realities of a difficult market in Industrial Distribution, as well as weakness in the commercial aerospace market. We will provide our perspectives on 2010 a little later, but first I will overview our operating performance, starting with aerospace.

The aerospace segment reported a full year increase in revenue, driven by higher Black Hawk cockpit deliveries and JPF sales, increased sales of SH-2 spares to New Zealand, higher blade erosion coding program sales and a full-year sales from Brookhouse. These increases were partially offset by lower sales of commercial bearings primarily for the business in regional jet market in the absence of Australian helicopter support center program sales. During the fourth quarter our erosion coating sales increased and we won several new contracts including a $7 million follow-on option from the US Army.

Despite an overall decline in revenue during the quarter, our operating margin actually improved by 380 basis points compared to the prior year. This was driven by a higher mix of FMS sales from option five of the JPF contract and tight cost controls that resulted in higher margins on bearing product lines despite the softness in revenues. And in late January, we successfully completed a demo of the unmanned K-MAX for the US Marine Corps. We were very pleased that despite horrible weather conditions, we met or exceeded the customer requirements, including remote control and autonomous flight beyond line of sight. The entire team, both our folks and those of Lockheed Martin worked literally around the clock to accomplish this goal and I wanted to use this as an opportunity to thank all of them personally for their efforts. We are a long way away from this being a meaningful revenue generating program for Kaman but the demo was clearly an important step forward. The unmanned K-MAX project demonstrates that while the challenging environment has forced to us reduce our spending in a number of areas, we have not reduced our investments in engineering and development as we continue to pursue new applications and expand our served market.

With that, I will move on to the Industrial Distribution. In the fourth quarter, revenues declined by 20%, or 14.7% on a same day sales basis. There were 64 days in the fourth quarter of 2008, versus 60 days in the fourth quarter of 2009. We also still had a fairly tough comp since in the fourth quarter of 2008, our sales were up by 7.5% over the fourth quarter of 2007. Overall, while sales per day for the fourth quarter were slightly weaker than expected, we are encouraged by the sequential improvement in sales we have seen so far in 2010.

We have continued our focus on price discipline, and our gross margin at KIT was up for both the quarter and the year, despite lower rebates, while maintaining our market share in key national accounts. Furthermore, due to the cost reduction initiatives that we implemented during 2009, we were once again able to improve our operating margin on a sequential basis, and at this point feel confident in our ability to leverage incremental volume going forward.

We were also very pleased to announce two Industrial Distribution acquisitions this week. The first is Allied Bearings Supply, headquartered in Tulsa, Oklahoma. Allied is an industrial distributor with sales of about $20 million a year whose product lines are similar to Kaman's. The company has eight branches in Oklahoma, Arkansas, and Texas, and strengthens our presence in markets such as Tulsa and Oklahoma City, and adds new markets such as Fort Smith, Arkansas. There are several key reasons why this is a great acquisition for Kaman. First, it adds to our scale which is important to leveraging our fixed cost base to reach our longer term operating margin goal of 7%. Second, it adds to our geographic footprint, which enhances our ability to serve national accounts without investing in green field facilities and it also increases our exposure to the energy sector, an area where we've had only a limited presence. Throughout its 76-year history, Allied has earned a reputation as a very well-run business with a keen focus on technical excellence and customer service, which makes it a great cultural fit for Kaman Industrial Technologies. We expect the acquisition to close early in the second quarter.

The second acquisition is Fawick de Mexico, a distributor of fluid power and lubrication products based in Mexico City. Strategically, this is a great fit for our existing Mexican operations and adds a very technically capable sales force and high-quality product lines. We expect this transaction to close later today. We're very pleased with both acquisitions, and feel that they will provide significant momentum for our KIT business as we enter 2010.

With that, I'm sure all of you are interested in how we see 2010 shaping up. So I will give a brief overview and Bill will provide a few more specifics on our programs in a few minutes. Commercial aerospace market conditions appear to be stabilizing but remain soft. While the rate of decline is not as sharp as what we have previously seen, passenger traffic remains down and new order activity for air transport class aircraft is still very weak. Business jet new order activity is also down significantly with approximately 750 to 800 business jets delivered in 2009, compared to more than 1,100 in 2008, and industry experts do not predict a recovery until 2011 or 2012. We continue to benefit from our higher concentration in military markets which remain fairly stable, although we do expect some variation on individual programs.

At KIT it's difficult to forecast when or what the shape of a recovery will look like. However, to provide some perspective, while all but one of our end market groups was down during the fourth quarter, the continued pressure that we are seeing on our sales primarily relates to three customer groups -- mining, minerals and OEM equipment which accounted for more than 60% of the sales decrease we experienced during the fourth quarter. A recovery in these end markets is important to our achieving our targeted sales growth in 2010. Additionally, I have spoken in the past about how important acquisitions are to our growth strategy, and that continues to be the case. We are clearly seeing increased acquisition activity as demonstrated by the two acquisitions announced this week, and are optimistic that there are more to come. We have active pipelines in both of our businesses with perhaps more activity on the distribution side at the moment.

In summary, while the realities of challenging markets in Industrial Distribution, as well as weakness in the commercial aerospace market still persist, we will continue to invest in new applications and markets for our products, pursuing both organic and acquisition growth opportunities while tightly managing our costs in order to maximize cash flow.

Now, I will turn it over to Bill Denninger to walk you through the financials in more detail. Bill?

Thanks, Neal, and good morning, everyone. Fourth quarter sales were $269.1 million, down 15% compared to the fourth quarter of 2008. Driven by a 20% decline at KIT, and a 7.6% decline at aerospace. Foreign currency translation positively impacted fourth quarter sales by $1.4 million or about 0.5% compared to the prior year. For the full year, our total sales declined 8.6% to $1.15 billion, compared to $1.25 billion in 2008. Currency translation negatively impacted full-year sales by $12.3 million or 1.1%.

Net earnings for the quarter were $8.3 million or $0.32 per diluted share, up 23% compared to $0.26 in the prior year. Net earnings for the full year were $1.27 per diluted share, compared to $1.38 in 2008. On a segment basis for the quarter, Industrial Distribution sales were $149.8 million, down 20% year-over-year and down 14.7% on a sales per day basis. Sequentially, sales were down 8%, as we usually see a seasonal decline from the third and the fourth quarter. Segment operating income was $3.4 million, down 43%, compared to the prior year, but flat sequentially despite the seasonal decline from Q3 to Q4, due to improved gross margin, and cost reduction initiatives. As a result, operating margin improved by approximately 20 basis points compared to the third quarter.

With respect to gross margin, keep in mind that we account for our inventories on an average cost basis, so in this environment of declining inventories, we did not have the benefit of LIFO income increasing our gross margin. As Neal mentioned, the progress we have made in improving operating leverage at KIT should help us move towards our operating margin goal of 7% as volumes return.

Moving on to aerospace, sales in the quarter declined 7.6% to $119.3 million. Operating income was $18.2 million, up 24% compared to the prior year, resulting in margin expansion of 380 basis points to 15.2%. This improvement was primarily due to improved margins on our JPF program, as well as higher margins on bearing programs due to overhead cost reductions in this area and reductions in G&A expense within overall aerospace. Aerospace sales in the fourth quarter were lower than we anticipated. We had approximately $13 million in JPF shipments to the US Government that were not made in Q4 due to an issue with a vendor supplied component. We expect to make these sales in 2010.

Pension expense was $3.9 million for the quarter, rounding out the year to $15.8 million, up from $7 million in 2008. We are making some significant changes to the Kaman's pension plan this year. As of March 1, our pension plan will be closed to new employees. Average final salary will be frozen at the end of this year and credited service for all participants will be frozen at the end of 2015. This was a decision we did not make lightly, but one that we felt was necessary for the long-term health of our Company. As we have seen over the last several years, pension can create significant volatility and impact earnings, cash flow, and shareholders' equity. We have structured the change in the plan to allow for a responsible transition period, which will lessen the impact of those employees nearing retirement and allow others to adjust their retirement savings strategy. As a result of these changes and other factors, we expect our pension expense to decrease about $5 million to approximately $11 million in 2010.

Moving on, our effective tax rate for the fourth quarter was 30.7%, with a full-year at 30.6%, which is in line with our prior expectation for a range of 30% to 32%. For 2010, we expect our full year effective tax rate to be closer to a normalized rate of 35%. Capital expenditures were $14 million for the full year 2009, which was equivalent to a maintenance level of spend. We expect CapEx to increase to $20 million to $25 million in 2010, due primarily to a number of IT investments we are making at KIT and at corporate. Cash flow exceeded our expectations in the fourth quarter as we generated over $17 million in free cash flow, driven by improved working capital management and lower inventories at KIT. KIT generated more than $21 million of free cash flow for the year, due to aggressive actions to reduce inventory and expenses. Aerospace generated nearly $44 million in free cash flow, driven by earnings, reduced inventories, related to Fuzing programs and lower bearing product line inventories as a result of the lower sales volume. Overall for the year, we generated $57 million of free cash flow, which compares to a use of $30 million of cash in 2008. We have significantly improved our cash generation capabilities and expect 2010 to be another year of positive free cash flow.

The solid cash generation allowed us to continue to strengthen our balance sheet in 2009, despite the difficult economy. Our leverage remains low with a year-end debt to capitalization ratio of 16.9%, and we have no significant near term debt maturities. We expect to take advantage of this financial strength to pursue accretive acquisition opportunities in 2010, such as the two we announced this week.

I would now like to provide some additional detail on our outlook for the remainder of the year. In Industrial Distribution, as Neal mentioned, we have limited visibility. We expect the sales will begin to improve in the first half of 2010 with improvement continuing in the second half, resulting in a full year sales increase of 3% to 6%, compared to 2009. We have seen a nice uptick in January and February sales trends and would hope that we would see sales growth at the high end of that range. With a contribution from sales growth partially offset by nonrecurring benefits, one-time cost savings in 2009, we expect our full year operating margin at KIT to be approximately 50 to 100 basis points higher than 2009's 2%. The sales outlook I mentioned is strictly for organic growth and does not include the impact of any acquisitions. The two distribution acquisitions we announced this week should add $18 million to $20 million to our full-year 2010 sales.

In aerospace, we continue to face difficult markets for commercial and regional and business jet aircraft as well as the rate reduction on the Boeing 777. Volumes of Black Hawk cockpits and JPF Fuze shipments will be down somewhat in 2010. Offsetting this will be ramping deliveries on several programs such as the Boeing 787 and A10 re-wing program. We expect our bearing product line sales to be about flat for the year, but with a very light first quarter. As a result, we expect full-year sales to be approximately flat with the second half of the year stronger than the first half. We expect full-year aerospace operating margin to be up 50 to 150 basis points due to higher JPF pricing and expense reductions we have made in this business, partially offset by a mix shift away from our higher margin bearing product sales. This aerospace outlook does not include any sales related to the Australian helicopters or unmanned K-MAX deployment, although both are possible. And as with distribution, these projections do not include the impact of any acquisitions.

Keep in mind, in 2010, we will experience higher corporate, interest and income tax expenses. We expect our corporate expenses in 2010 to be in the range of $8.5 million to $9.5 million per quarter. Interest expense will be up about $3 million year-over-year, before the impact of higher borrowings to fund acquisitions.

In summary, while the continued challenges in the markets are likely to dampen any significant improvement in our financial performance in the first half of the year, we will continue to invest in business development, evaluate acquisition opportunities, and keep a close eye on managing our expenses and working capital in order to maximize cash flow generation and overall profitability.

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

Thanks, Bill. Before we take questions, I want to add a few closing comments. We could not have weathered what was a very challenging year for many of our businesses without the continued hard work and effort of all of our dedicated employees. I want to extend a thank you to each and every one of them for their continued commitment to the level of innovation and execution that helps set Kaman apart from our competitors. I would also like to thank our customers for their continued confidence in our ability to meet their needs and improve their competitiveness. Looking forward to 2010, we believe the actions we took during 2009 have positioned Kaman as a much stronger company and will enable us to take full advantage of opportunities as our markets begin to improve.

That concludes our formal comments and with that I will turn the call back to Eric.

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

(Operator instructions) Your first question comes from the line of Arnold Ursaner of CJS Securities. You may proceed.

My first question relates to a clarification from Bill, if I can. You mentioned on Industrial Distribution, you expect sales up to be 3% to 6% and you gave us, of the acquisitions you just completed, are $18 million to $20 million. I just want to be clear, that is included in the 3% to 6%, or not included?

That's not included. That would be on top.

Okay. And the second question relates to your operating margin view that you might be 50 to 100 basis points up, but you are up from a 2% level. If we look back historically at Industrial Distribution, you had margins much closer to 4.7%, 5.3%. The question I'm grappling with is with all the acquisitions you have made, with the leverage in the business, with the expenses you have incurred in the last two years to build out footprint with national accounts, despite all of that, you are still meaningfully below where you were two years ago. Can you care to comment on how we move closer to the 7% goal?

Sure. Two years ago, our sales were $777 million. They are still running quite a bit below that and it all comes down to scale. An improvement of the sort we are talking about is really based on volume, that's the key driver. If we get the volume at the high end of the range, then I would expect our margins to also be at the high end of the range we gave.

Maybe another way to ask the question is what sort of incremental margin is built into your operating margin at this point for KIT?

It's around 15% to 17%.

Okay. So you are really highly leveraged, as you say, to volume.

Right.

The other question I have is on aerospace. Can you just give us a quick update on Wichita and the status there after the various cost reductions and your need to add some volume?

Sure, Arnie. I think that we've continued to make progress. I think we reported that we've gotten through all of the customer audits and are now able to bid work for all of the customers. We've also gone through our ISO audits and NADCAP audits and passed all of those, the most recent with absolutely no findings. Again, we feel that we have a good baseline established now from an operational perspective in Wichita but we still do need the additional $4 million to $5 million of revenue to turn it profitable and that's where the primary focus is right now for that facility.

Okay. If I can ask one final question, you obviously are very clear that you are not including the unmanned K-MAX in your guidance, but would you walk us through some of the scenarios you see unfolding and how it could impact either 2010 or 2011?

Sure, Arnie. We tried to be clear on that. As we said, we are really pleased with the outcome of the demonstration. As I said, the weather conditions were absolutely horrible, but we were able to successfully meet all of the requirements and, quite frankly, had a couple surprises that the Marine Corps asked us to respond to, which the team did. Originally they had a deployment target for three aircraft in 2010. There have been some delays with other demonstrations. We were hoping that they continue down that track.

We are not sure what the procurement would be, if it would be for aircraft to be flown by the Marines or whether it would be a service contract, where Lockheed Martin and Kaman would provide equipment, remote pilots and in-theater maintenance. We just don't know that yet. They haven't developed their concept of operations. But we would expect that in the next two to three months we would receive a request for quotation, that we would respond to that, we would certainly hope that they are able to hit their original timeline of deployment of three aircraft yet this year. And quite frankly, from that, Arnie, we are not sure. It's going to depend on what their requirements are going to be. If it's a 10-unit order or a 30-unit order, we just can't tell yet.

You lead to an obvious follow-up question. Given the problems you had for years -- and it was an extended period of time on a fix-priced contract on the Australian helicopters -- how do you plan to package this to avoid financial risk for your shareholders going forward?

Arnie, it's a great question. We have spent, as you would expect, an extraordinary amount of time making sure that we understand everything that' required in this bid. The K-MAX aircraft is a much simpler aircraft than the SH-2. With the SH-2, as well, as you know, we undertook some very, very sophisticated avionics and software modifications to that aircraft and had one of our key suppliers default during that contract. So we do not have that responsibility in this part of the contract. Lockheed Martin is not only a strong partner but they have a well-developed and deployed mission management system that we are adapting to our aircraft. So I believe that with those steps taken, that we are looking at it as a risk neutral program with very good upside opportunities, both from an earnings perspective and certainly from a cash flow perspective.

Thank you very much.

Your next question comes from the line of Stephen Levenson of Stifel Nicolaus. You may proceed.

Thanks, good morning, everybody. Hopefully you didn't run into this type of weather with the K-MAX.

It's a little bit worse icing on the road, versus on rotor blades.

Just a couple of questions. Do you have a hint on when you will start to see some of that 787-related business begin to build?

Steve, we would expect to see it in the second half of the year. The primary reason for that is that, as many suppliers did, we supplied a fair number of shipped sets of products early on in the process and, in fact, saw a sizable gap in orders and deliveries in 2009 because of delay in the construction of the aircraft. So now, there arguably is between 30 and 40 ship sets in the pipeline. So for that to clear, the first half of the year is what our expectations are for that to clear, and we would expect to see orders in the second half of the year.

Okay. Thanks. On the defense budget for fiscal 2011, that's proposed, there seems to be an awful lot of money for helicopters. So I know you said that H-60s are going to be a little lower this year but what's your view on the way the budget plays out and how it impacts Kaman?

We feel very good about how the budget turned out, Steve. We can touch on C-17 and certainly with that being extended, that has helped us significantly. And also as you said, a tremendous amount of spending on helicopters. I think that long-term, that is clearly a very good program for Sikorsky and in turn, a very good program for Kaman. What we are running into a little bit in 2010 is that we caught up to their delivery ramp, delivered about 155 cockpits in 2009, and we expect that to come down to a more sustainable level of 140 to 145 in 2010. So, it's a good program for us. It's very solid. We had some upside during 2009, as we and Sikorsky caught up on deliveries and now we are going to be at a high, albeit, slightly lower rate for 2010.

Okay. Thanks. And do you see getting anymore work, like the wiring harnesses and hydraulic lines?

We are working that opportunity every day. The key thing there for us is really to demonstrate the ability to meet the needs of Sikorsky both from a cost perspective, certainly from a quality perspective, and also from a reliability of supply perspective. We think being selected in Jacksonville as one of the top 100 suppliers for Sikorsky demonstrates that we are delivering in all three of those aspects. We are positioned to get it but we have to win the work and we have to be able to win it at an acceptable price level for us, as well.

Got it. Thanks. Now I'm with you on the feeling about business jets being slow, but there's been some commentary to take-offs and landings are better and the used inventory is down. Could you expand on your outlook a little bit, please?

You're right, that is a phenomena of just the last couple of months, Steve. However, historically, that market has trailed an increase in corporate earnings by about 18 to 24 months. I think that when you combine that with a lot of the press certainly about business aircraft being very negative, it impacted us. I don't believe we are going to see a return until late 2011 or 2012. They are down from 1,100 aircraft to 800 aircraft. I believe the industry experts are saying there will be between 625 and 650 in deliveries this year. We may see a small uptick a little bit earlier than normal, but I still believe it's going to be late 2011, 2012 before we see a return.

Okay. Thanks very much.

Your next question comes from the line of Ed Marshall of Sidoti & Company. You may proceed.

Hi. Thanks for taking my call. The sequential decline in the Industrial Distribution, and I understand the seasonal patterns there but considering what some of the competitors have been saying, I want to focus on 2010 and maybe the head winds that you may be facing as surrounding pricing pressures or anything along those lines that you may be facing in 2010.

Sure. Ed, first of all, we had an 8% decline from third quarter to fourth quarter. We had four fewer days so simply on a change from 64 to 60 days, that would be a 6% decline. So that's point number one. I think number two is that as we said during our prepared comments, we had a pretty strong fourth quarter of 2008 that we were comparing against at 7.5% growth. So I believe that the downturn hit a number of our competitors earlier than ours. So there's probably a quarter lag on comps there.

The other is that a couple of our big competitors certainly have a bigger exposure to the automotive industry and that's certainly got a bump. I think as you go back and look at their commentary, they commented in their earnings calls that they saw a bump in automotive. We don't have much exposure to automotive. It helped us on the way down, it's probably helping them a little bit on the way up. And commodity prices did not come back up at a rate that would have helped us.

And the last point probably is that we had commented on the potential for seeing some extended plant shutdowns and I think that we did see that somewhat in the second half of December. In terms of pricing pressure, I think that obviously, it's a very difficult and very competitive pricing environment, but as Bill commented, we actually improved our gross margin for the quarter and for the year despite the fact that we had significantly lower rebates. I think it underscores, as we've tried to highlight the last couple of calls, is that we've really focused on our pricing discipline and think that we are getting some benefit from those initiatives.

And finally I would say, we have said, as Bill said, a nice 7% increase in both January February from the fourth quarter sales levels. So we're pleased with what we've seen so far, but obviously only two months into the year, we're not going to celebrate too much. We've got a lot of work to do.

Okay. Fair enough. The timing of the push out on the Fuzing sales, did you mention as to when you expect those to hit? You did say 2010, but is there a specific quarter, first half, second half? Anything you can provide would be great.

It's going to be spread a bit. Probably starting second quarter and wind up in the third quarter.

Okay. And an update on the Australian helicopters, is there potential buyers? I did review what you have mentioned in the K. Is there anything else you can provide?

I think the K summarized it pretty accurately. We are working pretty aggressively with six countries right now. We have two that are leading the pack that either have the aircraft in their inventory today, or have been to both Bloomfield and one of the countries operating the aircraft and flown the aircraft with that military. So we continue to make progress, but as we have said before, it is a lengthy process but we feel good about our ability to get a contract during 2010.

Okay. Thank you guys, very much.

Your next question comes from the line of Jack Atkins of Stephens, Inc. You may proceed.

Good morning, this is Jack on the call for Matt Duncan. Thanks for taking my question. My first question is with regard to the revenue results at KIT. KIT seems to have underperformed your own expectations given the guidance that you guys issued in mid-November, which called for, at worst, flat sequential sales. And then if you look at the sequential sales results for the December quarter for some of your larger peers, they saw some sales increase there. And so I'm just wondering if you can maybe give us some additional color on what specifically happened in the last half of the fourth quarter which led to the weakness at KIT. Was it the market recovery that you were anticipating, did that not materialize or do you think you are possibly losing some market share to some of your larger competitors?

Jack, I will start with the last point. I don't think that we're losing market share to some of our larger competitors. Again, I would go back to two things. One is that it would be interesting for you to go back and look at the comps for those larger competitors that you are referring to, and see how their 2009 versus 2009 -- or 2008 versus 2007 fourth quarter lined up and I think it might be different than the 7.5% growth that we had. And, in fact, if you go back to a year ago, there were comments on exactly the opposite about them losing share to us because the decline hit us a little bit later. But I think that was primarily due to the very different end markets that we serve.

We didn't do as well as we had hoped in the fourth quarter. We thought that we would have higher sales in the month of December than we did. That is what brought us down. It was fairly widespread. It was not any one industry we could point to, Jack. And, again, we do believe that we had a number of our customers that used the holiday period for extended shutdowns and that rolled right through to our business. So we were disappointed in the lack of growth in the fourth quarter. I think we were able to demonstrate that we had very good cost controls as well as very good pricing discipline to demonstrate another sequential improvement in the operating margin of that business. And now as we start 2010, are beginning to see some of the uptick in volume that we had anticipated.

All right. Thank you for that color. And then looking at the two acquisitions you guys announced this week, could you give us a sense for the margin profile on those businesses? Do you expect them to be accretive in 2010 to EPS? And then maybe if you could just comment on just the broader M&A environment, are you seeing things loosen up there?

In terms of operating margins, both of them are higher than where KIT is today. Neither of them will be accretive in 2010, but both will be accretive in 2011.

In the broader M&A environment, we have certainly seen a convergence between the bid and ask prices. The Industrial Distribution area is probably a little bit ahead of aerospace there, Jack, but we have active discussions in both areas right now. It's certainly much different than a year ago where there was just a fundamental disconnect between our evaluation of a business and the sellers price expectations.

Okay. Great. Thank you for that. Just a couple of follow-up items here. On the tax rate, Bill, could you give us some guidance on what tax rate we should be using for 2010?

Yes, we expect to return back to a more normalized 35% rate for 2010.

Okay. Great. And then just to go back to your comments on your anticipated quarterly interest expense for 2010, could you go over that again? And then does that include the increased borrowings for the two acquisitions that you announced this week?

The interest expense we said would be up about $3 million year-over-year. And keep in mind that interest expense includes the amortization of the fees that were paid up front for the revolver renewal back in September, and they were substantial given the market. And that projection does not include incremental interest expense related to higher borrowings to fund any acquisitions.

Okay. Great. Thanks for the color, guys.

Your next question comes from the line of Josh Pokrzywinski of KeyBanc Capital Markets.

Good morning, guys. Just trying to calibrate some of the comments around the weak first quarter in Commercial Bearing, around that and offset by an uptick in Industrial Distribution. Could we see earnings down sequentially 4Q to 1Q?

Hold on one sec. We would expect to see a decline quarter to quarter.

Got you. Presumably higher corporate expense too, as you are rolling through some of the due diligence costs in the first quarter.

Yes.

And then just to follow-up on an earlier question about when we see a return to the historical margin trends in KIT. Just going back to 2006, when you were at peak margins at 5.3%, we're bumping up against that revenue base here this year, and I understand there's more overhead for some of the acquisitions you've done, maybe the rebates are not as favorable right now. What does it take since we are more or less at that volume game right now, what does it take from here to get back to the 5.3%? I understand the leverage dynamic in needing more volume. It just seems like we are close to it.

If you go back to 2008 and think about $777 million of sales, 4.6% ROS. Sitting here right now, I would say we need to be approaching $800 million to bring it up to 5%.

Okay. So the $665 million in '06, you were above 5%. The business looks different enough today to where --

I think the annual cost increases, just economic increases have driven the ball higher.

Okay. That's fair. And then just separately, when do you expect to start seeing participating in the rebate game again? It seems like you guys have done a good job taking down inventory. Presumably purchases will be up quite a bit here pretty soon just from the absence of destocking.

Right. Our outlook for 2010, the information we have given, does assume a higher level of rebates in 2010 than 2009.

And when should those start showing up? Are those first quarter?

We accrue for them each quarter so it would be in the first quarter, yes.

Okay. Good color. Thanks, guys.

Your next question comes from the line of Robert B. Kirkpatrick of Cardinal Capital. You may proceed.

Good morning. Bill, you mentioned that you expected positive free cash flow in 2010. Previously, I think you had guided to greater than $40 million for 2010. Are you backing away at all because of the success that you've had during 2009?

I don't know that we've given any guidance on free cash flow for 2010. Right now, given the very favorable performance in the fourth quarter, we are not going to be seeing that piece of it in 2010, and we're looking at something in the range of $20 million to $30 million of free cash flow in 2010.

Okay. And then did I hear you mention that you expected that you would have less sales on the Fuzing side in 2010 versus 2009 or did I mishear that?

No, initially that was our thinking, but with the delay from the fourth quarter into 2010, the $13 million, because of a component issue, we now expect that Fuzing sales will be up slightly.

Okay. And I had thought that with the move to option six, that that might have been more of a tail wind. Is there something going on outside of JPF that is affecting that?

We are going to see higher pricing, as we said on JPF starting if Q2, but we are seeing lower number of units shipped in 2010. There was a catchup in 2009 which doesn't repeat.

Okay. Great. And then if you do go forward with something for the Marines or the military on the K-MAX, does that show up as a joint venture in other income, or does that show up as a consolidated item on your income statement?

We would likely, although we haven't sorted everything out, but we would likely be selling a helicopter to Lockheed who would be prime on any contract. That's our current thinking.

Okay. That's great. And then is there a difference in number of days in KIT in 2010 versus 2009?

Hold on one sec. December of 2009 was 22, and '10 also 22. Did you ask for December?

No, I'm sorry, for the year 2010, versus the year 2009.

2010 has one less selling day, 252, versus 253.

Okay. And then the freezing of the pension plan, what's the long-term effect of that? You talked about the shorter term effect will be a $5 million decrease in pension expense in 2010 versus 2009, but assuming that you earned the targeted returns and assuming you don't change the discount rate, what's the longer term effect? Does it stay at that $11 million a year or does it change substantially?

In 2015, when the plan is fully frozen, that's when we see the full benefit in terms of both expense and cash and compared to what it otherwise would be, would expect something in the area of $15 million reduction in each year.

$15 million reduction in both the income statement effect and the cash flow effect?

Right. Compared to what it otherwise would have been which was a pretty hefty number.

And otherwise, it would have been how high at that point?

It's tough to really say, something in the area of $30 million to $35 million.

Okay. All right. And then a last question for Neal, since I was ignoring him. As a long-term shareholder here, what should I be worrying about?

From my perspective as a long-term shareholder, Rob, what we really are focused on is continuing to build our business development activities, both in helicopters, because if you look at the upside potential that we're staring right in the face of, it's SH-2 sales and K-MAX sales. Those are the upsides that we are really keenly focused on. We also have to begin to prepare for, and we are preparing for what we are beginning to see, a flattening out of some of the big programs that we are on, whether it's JPF, whether it's Black Hawk and what we're going to do to continue to increase our aerospace sales. Now, the end of this year, we will see 787s start to come in, as we said. We'll see A-10s start to come in. But on the aerospace side, it's really our ability to win new programs at good price levels. That's the key thing for us, because we are a program-related business there.

Also we've obviously made investment in additional people and application engineers for our specialty bearings business to be able to continue down the path of getting more content on every new aircraft, whether it's 787 or now the A-350. So wins for our specialty bearings product lines, new aircraft. And on the industrial distribution side, Rob, it really comes down to, again, our stated objective of being able to increase our scale, fill out our geographic footprint, sustain the pricing discipline that we have demonstrated over the last year and make progress towards that 7% longer term goal. But those are the key things. I think we have dealt with a couple of the systemic issues this year, as well in terms of the change in our pension plan, change in our approach to our medical plan, so that we are able to balance the needs of our employees with the needs of the Company to be competitive in our bidding for new program and for our shareholders over the long term.

Great. Thank you so much.

The next question comes from Jim Foung from Gabelli & Company.

Hi, good morning. Just starting on the K-MAX, you indicated the US Marines were looking to procure three aircraft this year. If they do that, when do you think you might see the first order for that?

Jim, we're, I hate to use the word hope, but we're anticipating if I can use that word instead, that in the next two to three months we will see a request for quotations from them. They had said that they would do it early in the year. As we commented a little bit earlier, Jim, there have been some delays in other demos. So we want them to move, we are not sure if that will be a gating factor for them in the release of the RFQ.

Okay. So if it happens, it could be as early as two to three months then. And then production, how long would it take to produce and ship these things?

We have three aircraft that we have in our program right now, that we have between Lockheed Martin and Command for this program right now. So we could meet the need of the initial RFQ from aircraft that we have.

Could we see incremental revenues from that this year?

Jim, we don't know. It's going to depend solely on the timing for the request for quotation, and the amount of time that it takes for the Marine Corps to evaluate the bids and release an order. Their initial goal in the fall of last year, in the late fall of last year was to have aircraft in theater during 2010. We stand ready to support that requirement.

Okay. And then just on the aerospace, you alluded to the fact that the Fuzing business sales in 2010 would be slightly better than 2009. Are you looking for Specialty Bearings to be slightly better than 2009, because of the 787 production coming in the second half of 2010?

At this point, Jim, we are expecting bearing product line sales to be roughly flat with 2009, based on all the indicators we are looking at, based on looking at the backlog and based on looking at a weak first quarter. We hope we are wrong, but that's the way we see it at the moment.

Okay. Then I was wondering if you can just talk about the helicopter. So is that going to be up then in 2010 versus '09? And then Aerostructures to be flat in 2010 versus '09?

From a program perspective, Jim, with are expecting the Black Hawk production rate to be down somewhat, as we said earlier, about 10 to 13 cockpits. We also know that we had very high New Zealand spares orders during 2009, where they took advantage of some of the equipment coming back from Australia, that we were able to quickly resell to the New Zealanders. Overall, we also know that the 777 is going to index down from seven a month to five a month. Those are things that we are looking to offset, frankly, with some of the later-year ramp up on 787, and also A-10. But we wouldn't see a lot of growth there from year-to-year, certainly as we have to offset those two big swingers for us. So lower Black Hawk cockpits and the reduced rate on the 777.

Just lastly the lower pension expense in 2010, will that $5 million less expense there run through the P&L?

Yes, it will.

Okay. So that's on a GAAP basis, so it seems like a $0.13 per share incremental earnings.

That's absolutely true, that's baked into our outlook. It's unfortunately offset by higher interest expense and higher tax expense.

Okay. Great. Thank you.

Your next question comes from the line of Ed Einboden of WM Smith & Co.

Good morning, guys. I was wondering if you could clarify or give some color on the management changes you have made, the attributes of each of the new presidents and the shift that provides those segments.

You're talking about aerospace specifically, right, Ed?

Correct.

What we did, really, was we took two steps. One was that we had a number of business presidents that we really wanted to align their strengths, better align their strengths to the businesses that they were operating. As an example, clearly we've said that our composites area is an area of focus and growth for us. Jim Larwood is now the President of our Combined Composites group. Jim was leading and did a very good job leading our Precision Products group, however, Jim's background is as a composite engineer from the Northrop Grumman days and here a long time with Kaman as well. In addition, he did an excellent job in business development with our government customers, and government customers around the world when he was serving as the president of Precision Products. So we really are looking to bring Jim's experience in composites, as well as his business development skills to help us optimize our composites business and grow it for the future.

At the same time, John Kornegay who had done an outstanding job leading our Specialty Bearings group, and as you can all appreciate, had done a tremendous job implementing lean across that business. We really wanted to take advantage of John's skills there and bring it to our Precision Products organization. We now have done a very good job of getting the volume up there and getting the pricing reset. Now we want to lean that out and improve the margin performance, and we believe very strongly that John will bring a great level of experience and skill to doing that.

And then our Sal Bordonaro continues in the role leading our helicopter business. And Bob Kanaskie continues in the role leading our Aerostructures business. And Richard Thorley who had been the head of our Brookhouse business is now working across the group to help in both our strategy development, our lean deployment, and our business development efforts. So for us it was really trying, as the business has matured, to be able to go forward and align the right people in the right spots.

And finally, as we've said before, one of the areas that we really wanted to focus on in our Specialty Bearings business was market expansion. And Rob Patterson, the gentleman that is now the President of our Specialty Bearings business has been the Vice President of Business Development for that business for almost 20 years, so we expect that Rob will apply his considerable strength and experience and business development to help us expand that business base.

Okay. Great. I appreciate that. And maybe a couple of questions on the acquisition environment. Has there been any shift or can you provide any color as to domestic versus international acquisitions and whether the bid/ask spread on the acquisitions has improved better here domestically or internationally?

All of the acquisitions we've considered for our industrial distribution business, Ed, have been domestic. So we couldn't comment on any variation between here and Europe. In the aerospace side, we've looked primarily at companies in the Americas. So I can't say that given the still relatively small sample size that we would go to the diligence phase on, that we would have seen any marked difference between Canada and South America and the US at this point.

Okay. And just on the Industrial Distribution acquisitions that you have made, if you looked maybe a year ago or two years ago, would the sales run rate that they had, would that be consistent with what you guys would have expected? And since the fall off has occurred recently, has that been inconsistent with what you guys have seen in the business? I'm just trying to figure out historically where their sales levels have been.

Ed, you are exactly right because one of the key things that we've examined through our diligence was if they experienced a decline, which they did, was it similar to the declines that we experienced? Going in, looking at it, also by customer so that we could make sure that it was not driven by any one customer, that they may have lost from a market share perspective. So we felt comfortable in our analysis, Ed, that the declines that they experienced were market related, rather than loss of any share or anything in the underlying performance of the business.

Okay. Great. Thanks a lot guys.

But we would certainly like them to tick back up to where they were a couple of years ago.

You have a follow-up question from the line of Arnold Ursaner of CJS securities.

I wanted to try to follow up on Rob Kirkpatrick's question regarding JPF. You mentioned at that time that you're seeing a higher pricing but less volume. I'm a little confused. So start with the facts. What was your production rate in 2009 and what do you expect in 2010? Why don't we start with that?

Our production in '09 was around 27,000 fuzes. I don't have the number for 2010 in front of me, but we can certainly get that for you.

What was it on a monthly basis or a quarterly basis? What was it in Q4 and what are you expecting in the current quarter? When does volume slow down?

It was around 7,000, and I just don't have those answers. I will have to get back to you.

And the reason I'm asking the question is my sense was that you were constrained in making foreign military sales until you satisfied the demands of the US Government. So my question is, if you have basically done that, if it sounds like you have done that, why wouldn't you have greater sales to foreign military entities at even higher margins? Why wouldn't it be more profitable? Why wouldn't you keep the production levels higher?

Arnie, a couple of things. One is that with a government procurement, many times it's based on a price level. So if the unit price goes up, the volume goes down. That's very common. You see that even now with a lot of the discussions around JSF procurements, et cetera. I agree with you about the opportunity for increased FMS sales. We do not have those orders yet. We are aggressively pursuing them, but we are not going to sit here on a conference call eight weeks into the year, Arnie, and talk about speculative FMS sales. When we get them, we will report on them, but unless they are on our order books right now, we are not going to portray those as expected sales in 2010.

What were FMS sales of the 27,000 you had last year?

About 8,000 were FMS, 28%.

Okay. Do you expect that percentage to be higher or lower in 2010?

Actually, I think it's going to drop to something closer to 15% of total shipments.

Okay. Thank you very much.

And you have a follow-up question from the line of Jack Atkins of Stephens, Inc. You may proceed.

Hi, guys. I just had a couple quick follow-ups here. First, just go back to the corporate expense guidance for a second. Even with the lower pension expenses, you guys are still expecting $8.5 million to $9.5 million in corporate expenses a quarter. Is that correct?

That is correct, yes.

Okay. So, if your pension expenses are going to be down over $1 million a quarter, but you are expecting your corporate expenses to be up year-over-year, walk us through what's driving that, other than due diligence expenses? What is driving that increase?

It's largely compensation related where last year we had frozen salaries. We did furloughs. There were a number of actions taken.

Okay. Okay. That's helpful. And then just one last thing here, following all the specific line item guidance that you guys gave us, we are coming up with $1.25 to $1.45 in implied EPS for 2010. Is that a fair range, do you think?

We just can't comment on your models. I would also mention just so you are aware of it, that the pension gets pushed down to the operating groups and a small piece left at corporate, so you don't see the full $5 million saving year-over-year at corporate.

Okay. Okay. Thank you very much, guys.

I would like to turn the call over to Eric Remington.

Thank you for joining us for today's conference call. We look forward to speaking to you again when we report our first quarter results in May.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.