Kaman Corp (KAMN) 2012 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Kaman Corporation second quarter earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I'd now like to turn the call over to Mr. Eric Remington, Vice President, Investor Relations. Please begin, sir.

Good morning. Welcome to the Kaman Corporation second quarter 2012 conference call to discuss our earnings results. Conducting the call today are Neal Keating, Chairman, President and Chief Executive Officer; and Bill Denninger, Executive 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 the plans and objectives of the Company or its management, statements of future economic performance, and assumptions underlying these statements regarding the Company and its business. The Company's actual results could differ materially from any forward-looking statements made due to several important factors described in the Company's latest filings with the Securities and Exchange Commission. Additionally, I'll note that our discussion today will include references to certain prior year non-GAAP financial measures. Reconciliations of these non-GAAP measures to our GAAP financial statements have been included in our earnings press release. With that, I will turn the call over to Neal Keating. Neal?

Thank you, Eric. Good morning and thank you for joining us today. During the second quarter, we delivered a strong performance from each of our businesses resulting in consolidated sales of $405 million and diluted earnings per share of $0.62, slightly better than we anticipated. These earnings are 17% higher than the prior year and 72% higher sequentially over first quarter results. Aerospace sales and profits were driven by an outstanding performance from our bearing product lines with sales up more than 20% year over year, while Industrial distribution delivered record quarterly sales and operating profit dollars, with an operating margin of 5.7%. In Aerospace, the performance of our bearing product lines was fueled by increased deliveries of military spares to the UH-1, Typhoon, and Tornado as well as increasing build rates at Boeing and Airbus.

The JPF Program team also delivered a solid performance in the quarter exceeding our quarterly delivery target of 5,000 fuzes. This puts us in position to reach and possibly to exceed our goal for the year of 20,000 fuzes. Year-to-date deliveries have been almost exclusively FMS sales so this leaves us opportunity to fulfill US government requirements and DCS orders in the second half. Potential upside from the JPF program will likely offset weakness in other Aerospace programs. The JPF program remains well-funded with a backlog at the end of the quarter of $121 million. The Air Force recently reprogrammed funds for additional JPF fuzes, setting lower than desired inventory levels. In connection with this activity, we are negotiating additional contract awards with the Air Force and several commercial customers.

During the quarter, we delivered 27 BLACK HAWK cockpits, 12 fewer than last year's second quarter. In addition to lower expected deliveries year-over-year due to customer demand, we experienced a supply chain disruption during the quarter. A Sikorsky component supplier developed a tooling issue resulting in a slowdown of our production line. We worked with the supplier and with our customer, Sikorsky, to replace the ruling, and production has resumed. After delivering 62 cockpits in the first half, we anticipate delivering 68 through the balance of the year for a total of 103, about 10 less than originally expected due to lower demand.

We mentioned on the first quarter call that we had entered into an MOA with Sikorsky for BLACK HAWK cockpit production under the Multi-Year 8 contract with the Army. In fact, we are now under a long-term agreement with Sikorsky securing this program, our largest in 2011, for another five years. The contract has an initial value of $200 million, but with [options] could be significantly higher. Our Unmanned K-MAX continues to be a great story and is a remarkably successful demonstration by any measure. To date, the two aircraft in Afghanistan have flown more than 520 missions, hauling over 1.6 million pounds of cargo. The Unmanned K-MAX has exceeded expectations and we are optimistic that the Afghanistan deployment will be extended. Concurrently, we continue to work with Lockheed on the Army advanced technology, UAS program. This includes the development and testing of a beacon delivery system, obstacle avoidance, situational awareness, autonomous retrograde capability. This program is currently funded through 2013.

We continue to pursue additional market opportunities beyond Aerospace for our specialty bearing products. This has been an ongoing effort, but for the last two years has included dedicated resources from our Industrial Distribution segment. With more than 1,000 customer-facing employees across North American industry, KIT provides market access that would otherwise be unattainable for our specialty bearings businesses. We have received some initial orders and while revenue is still modest, our investments are beginning to gain traction and we have promising opportunities including several undergoing field testing currently.

For example, we found a number of applications, including a large piece of earth-moving equipment that is experiencing unacceptable maintenance issues within existing industrial self-lube product. We have also identified a bottler currently using a fabric-lined bearing that is causing unplanned downtime and a customer with a cutting machine whose greased bearings are being contaminated by debris from the cutting process. While each of these opportunities are small, they represent the first steps in developing broader market acceptance and penetrations for our unique technology.

In addition to completing the BLACK HAWK Multi-Year contract during the quarter, we were awarded a number of other contracts. We received authorization performed design work from Boeing Philadelphia, adding a new customer and diversifying into defense programs from our traditional base of commercial engineering. [Aircell] in the UK rewarded us several significant contracts to the Trent 700 program. Additionally, we were also recently awarded an $8 million contract for the production of Tomahawk Missile Fuzes. In Mexico, we are gaining traction with customers and continue to win new, albeit relatively small, contracts but what is most important is that we are building our base. We continue to make progress with potential customers with the sale of our Seasprite aircraft and several weeks ago, we acknowledged that we are in discussions with New Zealand for the sale of the 11 helicopters. While we are unable to discuss the negotiations we are having with potential customers, we expect the process will likely take several months to complete with any of them.

Defense spending is an area of keen focus for us. We have reviewed all of our programs and are relatively confident in the near term stability of the revenue stream. Developments in Washington are being monitored closely and we are working to inform and educate our employees and how the outcome of this debate may affect our industry, our Company, and our employees. In the interim, while we do not expect a material impact to our programs, we have been begun to develop contingency plans in the event we are faced with significant cuts.

Moving onto Industrial Distribution, the segment posted sales of $258 million, up 7.9% on a same-day sales basis. Organic growth in the quarter at 2.1% was below our expectations. We saw increases in transportation, durable goods, mining and primary manufacturing end markets that were somewhat offset by declines in several of our largest served markets such as food, beverage, and paper manufacturing. In addition, we continue to see a market softening in certain OEM markets, particularly in the semiconductor and solar power areas. Broad-based indices indicate higher levels of manufacturing growth but they are influenced by automotive and energy end markets where we have relatively limited exposure given our geographic footprint. A bright spot for us continues to be acquisitions and we are pleased with their contribution to our revenue growth and profitability. We continue to evaluate acquisition opportunities that provide more end market diversity and will enable us to better manage through the business cycle.

The Industrial Distribution operating margin in the quarter of 5.7% reflects higher gross margin which was a record for the quarter and our eighth consecutive quarter of year-over-year improvements, SG&A expense controls and the leverage of SG&A expenses being spread over a larger sales base. In connection with our national reseller agreement with Parker, Industrial Distribution continues the process of converting several brands of fluid power products over to Parker, and this is [testing] well. We have thoroughly rolled out the Parker program and we will continue training initiatives in the coming quarters as we transition our customers. Our sales of Parker branded products on a same-store sales basis were up 40% in the second quarter. While this growth has been mostly offset by declines in other fluid power brands, we are pleased with the Parker program and we believe it is an important long-term strategic growth initiative for Kaman.

The Catching FluidPower acquisition is going well and the performance has exceeded our planned objectives as its core markets remain strong. They have a strong management team in place and are making investments to leverage the Catching operations. With Catching, we plan to grow both our fluid power products business and core bearing and power transmission platform in the Chicago area markets. Overall, we are pleased with our improving performance in each business and I remain confident in our plan for the year. I'd like now to turn the call over to Bill for some additional color on the numbers. Bill?

Thank you Neal. Aerospace sales in the quarter were essentially flat over last year; however, there were a number of year-over-year differences. The most significant increase was from our bearing product lines. In addition, we experienced higher deliveries on the A-10 re-wing program, higher commercial K-MAX service and support efforts and we have the contribution from Vermont Composites. Offsetting the sales increases were lower JPF shipments and lower revenue from the Unmanned K-MAX and BLACK HAWK programs. Aerospace operating margin reached 17.8% driven by the strong performance of high margin bearing product lines by helicopter programs including higher commercial K-MAX [sales] and the [Egyptian] upgrade program and the absence of FMU-143 litigation expense. Neal discussed the outstanding result of our bearing product lines with significant higher sales and gross margin contribution. I should note that military bearing sales grew at a rate 3 times faster than commercial in the quarter, but incoming military orders were actually down in the quarter. So we do expect to see a slowdown in the rate of sales growth going forward starting in the third quarter.

Another factor contributing to the higher bearing sales was progress made to a reduction of past due orders which had built up over several quarters as a result of continuing increased orders and production requirements, in some cases within our lead time window. Over time, this stressed manufacturing operations but the team made a great effort in the quarter, significantly reducing past dues and ensuring that our delivery performance remains world class. Free cash flow during the quarter was good at $13.5 million and we continue to expect free cash flow $30 million to $35 million for the full year. During the quarter, we completed negotiations of the acquisition of Florida Bearings and closed the transaction on July 2. Florida Bearings is a great addition to our Industrial Distribution portfolio, adding bearing and power transmission locations in South Florida where our presence was limited. Our acquisition pipeline remains full for both segments and we continue to pursue acquisitions aggressively. We are disappointed that we have not done more acquisitions in Aerospace, but we will continue to maintain financial discipline on negotiations.

We announced last week that we've embarked on a program to acquire a new state-of-the-art enterprise-wide business system for our Industrial Distribution. This system will consolidate 7 existing systems into one and support the three product platforms that we have developed within distribution. The total cost of a new system is $40 million to $45 million, of which approximately 75% will be capitalized. This Multi-Year project is underway and we have begun to incur expenses associated with the implementation. Costs and expenditures will be split over a number of years and depreciation and amortization of the capital costs will begin next year and ramp up over three to four years.

Hardware cost of a small portion of the total spend will be depreciated over three years with the balance of the cost expensed over 10 years. Our project plan is phased to avoid disruptions to our current operations and includes appropriate contingencies. The pace and size of acquisitions could affect the project schedule. The internal rate of return on this project in the high teens is very attractive. The cost and cash flow requirements associated with this program are included in our 2012 full-year expectations and we maintain our 7% 2014 operating margin goal for Industrial Distribution.

With our earnings release, we have reaffirmed full-year expectations for sales and operating profit in each of the businesses. However, we now expect to be closer to the lower end of sales and profit ranges for each segment. The upper end of the sales range in Aerospace is still achievable but less likely now mainly due to the push out of a potential Unmanned K-MAX bridge buy. At our current run rate, the low end of the sales range in distribution appears more likely. However, we have raised the bottom end of that range by $10 million for the expected contribution from part of bearings. And we now expect corporate expense to come in close to the $46 million high end of the range for the year.

We indicated on the first quarter call that we expected about 60% of Aerospace sales and profit to be recognized in the second half. With our results slightly exceeding our expectations in Q2, we now expect to record about 55% of our Aerospace sales and profit in the second half. Due to Aerospace delivery schedules including JPF mix, and the ramp up of several programs in Q4, we do expect a much stronger fourth quarter than third with a variation in net earnings for Kaman of as much as 20% quarter to quarter. In summary, our first half performance provides us with confidence that we will achieve our full-year expectations in each of our segments. Thank you and I would now like to turn the call back over to Neal. Neal?

Thanks Bill. We are pleased with our improved performance in the second quarter which allowed us to post solid first half results. As we've said, we are maintaining our full-year outlook and are looking forward to a strong close to the year. With that, I'll turn the call back over to Eric. Eric?

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

Thank you. (Operator Instructions) Matt Duncan with Stephens.

So to make sure I understand the guide there correctly, Bill, it sounds like in Aerospace, the revenue number in the 4Q is probably going to be meaningfully higher than it is in the 3Q. So of the 55/45 split in the back half versus first half, it sounds like we need to move some of the revenue probably to the fourth quarter out of the third quarter; is that fair?

Matt, it's about a $20 million or so differential quarter-to-quarter on Aerospace sales.

Okay, so that would be low [$150s-million] into 3Q and low [$170s-million] in the 4Q, I guess to get to the low end of the guide; is that right?

Hold on one second. Yes, you are pretty close.

Okay. Then in terms of the impact that's going to have on your earnings, I guess you said as much as 20% for the whole Company?

Yes.

A higher -- okay, just want to make sure I understood that correctly. Okay, looking at KIT then, can you talk at all about sales trends that you saw through the quarter, Neal? Maybe hit on what you're seeing in your various end markets and how things trended here at the end of July?

Sure. Matt, actually when we had our first quarter call, we weren't able to comment because we had numbers for April. April was flattish and we were up about 4% to 6% in May and then closer to 2% in June. So it was a little lumpy and on a comparative basis, 2011 month-to-month-to-month was fairly flat. So I think that gives you the trend. The markets were interesting for us. Year on year, we did a little bit better in paper, in chemical, primary metals, but in our strongest -- our historically strongest markets of food, mining and beverage and tobacco, we were down. That's where I think we have seen less growth year-to-year, less spending and that is having a little bit of a disproportionate impact on us. So overall, I think industrial production is down below what we had anticipated going into the year and that is being reflected true in our organic growth numbers.

Neal, how does July look so far? I guess maybe just relative to June; is it still trending in that low single digits?

It's flattish.

Okay. So if I'm doing my math right, your guidance for the full year, if you're going to come in at the low end implies organic growth of about 3% in the back half; is that correct?

Yes, that's about right, Matt.

So an acceleration off of what you're seeing in July for that to come to pass?

That is correct. I think if you look at first half overall, Matt, it is about the same overall first half to second half, but you're right, we'll have to see a little bit of an acceleration from July.

What gives you the confidence you might see that, Neal?

Well, Matt, I think there's a couple aspects to it. Number one is that certainly Steve Smidler and his team have put a number of programs in place to try to accelerate our organic growth and we expect to see some results from that. So we are holding ourselves accountable for being able to increase that growth rate.

That is the normal seasonality at KIT where the 4Q ticks down from the 3Q; correct?

Yes, that's exactly right. That's right. We have a couple fewer business days in there and normally the second quarter, taking last year out of the equation, normally, or two years ago out of the equation. Normally, second quarter is our strongest quarter. We have merit increases that come in, in the second half of the year that impact us a little bit. So, as we look at it to get to the low end of our guidance, we are literally about halfway there on both a revenue and profit margin year-to-date. So we've got to turn in about the same performance in the second half of the year with a couple fewer days.

Okay. Last thing and I'll hop back into queue. If you could talk a little bit more about the IT system you're putting in place at KIT. Just talk about what drove the need for that investment; how long have you guys been looking at this? Why did you choose the one you did? Then how comfortable are you with the estimates for both cost and then are you expecting any kind of revenue disruption at all to the business as you roll that out?

Was that one question? (laughter) Matt, we really started that process probably back in 2009, where, as you know, we went through an analysis of the organization at KIT. We established what we felt was going to be a more efficient and effective organization going forward to enable us to achieve the 2014 goals that we put out there. Simultaneously, we have looked at both our processes and our information systems. We believed that we would be able to make enhancements to our existing system to enable us to get there. However, as we went forward and accelerated our pace of acquisitions, in particular in the fluid power area and in the precision automation and control area, some of the requirements of those businesses such as [Kitting], et cetera, were very different than our traditional power transmission motion control businesses. So that is when we went back into analysis as to what would be required for us to enhance our existing system versus move to one of the more contemporary systems that are available today.

So that analysis really took place back in 2011 and in late 2011, we thought we had come to grips with the fact that we would need to make a change. After some success with some analysis and early conference room pilots, this year, we elected to go forward with Infor. We really chose Infor after assessing a range of suppliers that were out there primarily based on their experience in the distribution market. We think that their products and capabilities are extremely well suited for the distribution industry. I have experience with them from my time at Hughes Supply as well where we transitioned two of our major businesses to Infor while I was there. We believed that we have also put in place a very strong team of people with adequate resources to be able to manage the program from both a schedule and cost perspective within the parameters that we set.

(Operator Instructions) Arnold Ursaner with CJS Securities.

I have one on Kamatics. You indicated that it was up 20%. You also indicated that the military spares grew 3 times faster than commercial, orders were down, and you're seeing a slowdown. How should we think about growth in Kamatics in the back half of the year given how critical it is to your profitability?

We are still going to see some good growth, Arnie, mid-teens. It's going to be primarily driven by commercial rather than military but it's going to be a good second half.

Is there a way to quantify perhaps the one-time nature of the military spare work that you did in the quarter?

I don't really have that in front of me. We could take a shot at that.

Okay. My second question relates to JPF fuzes. You indicated clearly you haven't shipped any yet this quarter. Should we read anything into that about any problem of any sort or is it more just timing of the [lat] testing?

I wouldn't read anything into that, Arnie. We had good production and deliveries as we said in the second quarter. It wasn't trouble-free, but we feel good about being able to achieve the 20,000 for the year with some potential upside as well.

Jeff Hammond with KeyBanc Capital Markets.

This is Brett Linzey stepping in for Jeff. Just on the JPF, you talked about some opportunities there. Could you maybe help us frame up the opportunity and then when would we potentially see those discussions begin translating into potential deliveries?

Well, I think that right now we do have sufficient backlog where we could increase the delivery rate if our customer requested us to. So we also commented that to date, the deliveries that we have made have been almost exclusively for foreign military sales as opposed to the US government sales. In fact, we also commented that there was recently some reprogramming of about $20 million to the JPF by the Department of Defense because they stated publicly that their inventory levels were below where they would like them to be. So we would anticipate being able to increase our rate from the 20,000 to be able to meet that demand. We would expect it to be able to occur in the third and fourth quarter.

Okay. I guess a follow up on that. How do you guys think about optimal production capacity within that program? If you do see more interest from some of the foreign militaries looking out over the next year or two, I mean how should we think about potential production there?

Well, as we've said for this year, we really started the year with the goal of relatively consistent performance of about 5,000 units a quarter and that was down, frankly, from 6,000 units per quarter that we had done a couple years ago. We did that so we could have more level loading of the factory and also to enable us to be able to deal with any issues that might have risen. Quite frankly, in the first half of the year, we were a little bit below the 5,000 in the first quarter, a little bit above it, almost at 6,000 for the second quarter. So we would see -- if we don't experience any unforeseen problems being able to ramp that up over time, back to the 6,000 a quarter.

Scott Graham with Jefferies.

I was wondering if you could tell us what the Vermont contribution was this quarter?

We can certainly do that. Vermont was about $6.5 million in sales.

Then I guess the other question is about the acquisition pipeline. I know that your aggressive targets to grow each business has obviously a large acquisition component. What are you seeing out there in pricing? I know you said you maybe saw if you would be a little farther along on the pace of acquisitions but I understand that you can't -- you never know the timing of these things. If your pipeline is fat, that is great. But is there anything maybe a little closer to the finish line? Have prices come down a little bit? Can you maybe just give us a little color and if you wouldn't mind by segment?

Sure. Let's start with Aerospace. I think that's where we've talked most candidly about being behind in the acquired growth portion of our plan. Quite frankly, the prices that some companies have gone for recently are well above what we would have paid. So we don't feel bad about letting those go as they did. I think everybody's looked at some of the multiples and scratched their heads. We would love to hit $1 billion mark in 2014 but we are not going to overpay for acquisitions to achieve that revenue target.

I think that Greg Steiner, Phil Goodrich, and Bill have been very mature and also very disciplined in their analysis of what we were willing to pay for companies there. There are a number that we're looking at today that we are very hopeful that we will be able to bring in that would be a good fit and help us achieve our strategic objectives in that segment. But again, we are going to sustain the level of financial discipline in that analysis as we have in the past. So a little disappointing. The only thing that would be more disappointing would be to do a bad deal.

Just on Aerospace, in terms of multiples, I mean what we're seeing Defense side, we really have seen a drop in 6 to 8 times, commercial side probably 10 to 12. So quite a split there between commercial and defense.

On the industrial distribution side, again, we are looking at a number of companies. We completed the Florida Bearings acquisition which we are very pleased to add to our business down in Florida early in the quarter. We are seeing multiples in the 7 to 9 times range and again, we have a number of acquisitions that we are looking at there. So I guess we could characterize it as a fairly full pipeline in Industrial Distribution as well and currently much more reasonable multiples in that segment as well.

(Operator Instructions) At this time, I show there are no further questions in queue. I would like to turn the call back over to Mr. Eric Remington for closing remarks.

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

Thank you for your participation in today's conference. This concludes the presentation. You may all disconnect. Good day everyone.