Kaman Corp (KAMN) 2013 Q3 法說會逐字稿

(Operator Instructions). I would now like to turn the presentation over to Mr. Eric Remington, Vice President of Investor Relations. Please proceed.

Good morning. Welcome to Kaman Corporation third quarter 2013 conference call to discuss our earnings results. Conducting the call today are Neal Keating, Chairman, President and Chief Executive Officer; and Rob Starr, Senior Vice President and Chief Financial Officer.

Before we begin this morning, please note that some of the information discussed during today's call will consist of forward-looking statements setting forth our current expectations with respect to the future of our business, the economy and other future events. These include projections of revenue, earnings and other financial items, statements on the plans and objectives of the Company or its management, statements of future economic performance and assumptions underlying these statements regarding the Company and its business.

The Company's actual results could differ materially from those indicated in any forward-looking statements due to many factors, the most important of which are described in the Company's latest filings with the Securities and Exchange Commission, including the Company's 2012 Annual Report on Form 10-K and the current report on Form 8-K filed yesterday evening together with our earnings 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. Overall we are pleased with the results achieved by our operations resulting in earnings per share of $0.70 and diluted earnings per share from continuing operations of $0.68. Aerospace delivered strong results with improved contributions across many of our product lines while distribution operating margins increased over the prior year and sequentially as we continue to drive improved profitability despite lower than expected organic sales levels.

Starting with Aerospace sales in the quarter were slightly below our expectations primarily as a result of delayed initial AH-1Z deliveries. This deferral was partially offset by a number requested pull ins to meet their schedule demands. Operating margin in the quarter was 18.3% , 220 basis points higher than the prior year. Driven by higher fuzeing margins, higher bearing sales and increased profit across other product lines. The segment benefited particularly from our SH-2 helicopters programs including the New Zealand SH-2G(I) , Legacy New Zealand SH-2G spares and Egyptian SH-2 maintenance and upgrade programs all of which delivered outstanding performance. Sequentially the Aerospace operating margin improved by 50 basis points highlighting the strength and diversity of our programs across the segment.

We started the year with strong first half performance in Aerospace led by Specialty Bearing product lines , which benefited from several one time retrofit and upgrade programs that are not related to current aircraft production. As a result of this spike in sales in the first half of the yearBearing revenues declined as expected by approximately 10% sequentially in the third quarter. However, the core bearing revenues continue to grow and we remain confident in the performance of the business. In addition, the higher Aerospace operating margin performance during the quarter reflects meaningful improvement across our other product lines.

During the quarter we delivered approximately 4,200 JPF fuzes. The majority of which were direct commercial sales to a foreign government. While third quarter shipments were in line with our plans this compared to deliveries of more than 10,000 fuzes in the third quarter of 2012. The Black Hawk program continues its steady performance, and we were pleased to recently achieve the milestone 1,000 cockpit delivery to Sikorsky. We are about one year into our latest multi year Black Hawk contract and expect it to remain one of our largest programs. And our newest program the SH-2G (I) for New Zealand is ramping up nicely and is on time and on budget at this stage.

As highlighted in past calls our Aerospace group has many programs that are in various stages of development. The scope of new programs is unprecedented in our history. Programs of note include the AH-1Z for Bell , Learjet 85 and the Gulf Stream G280. I am pleased to report that we successfully finalized delivery of the first AH-1Z cabin earlier this month and anticipate completing the delivery of two additional aircraft before the end of the year. As we reach rate production on this and other programs, we expect them to contribute toward our increased profit and improved cash flow. Overall Aerospace is firmly positioned to continue to improve operational performance, ramp up new programs and win additional work to provide steady long-term growth.

Distribution sales were a quarterly record of $273 million up 5.7% over 2012. Organic sales per day were down 1.2% in the quarter driven by lower sales from our bearing and power transmission customers. Our OEM customers continue to be negatively impacted by difficult global market conditions and in addition several of our MRO end markets have not rebounded as strongly as we anticipated at the time of our last call. As we highlighted during our second quarter call, we expected year-over-year sales growth to tip positive during the third quarter and despite the challenging conditions we did achieve positive sales growth in September which represents our first month of positive year-over-year growth in 13 months and our highest month of year-over-year growth since January 2012. And remember this performance was against a difficult comp as sales in the third quarter of 2012 were up 10.1% over 2011.

We experienced strong MRO demand in transportation equipment, nonmetallic mineral manufacturing and chemical manufacturing with flat sales in mining which was an improvement over recent quarters. This strong demand was offset by weakness in the paper manufacturing and OEM markets. And during the quarter we also experienced sharply lower sales in Mexico due to a drop in project related volume from certain mining customers which negatively impacted profitability. However our electrical and automation platform has performed well and our acquisition sales in this area have exceeded our expectations.

Distribution sales growth has been slower than we anticipated but as we move into the final quarter of the year we expect additional growth from acquisitions and modestly positive organic sales growth trends as the economy continues its slow recovery. Overall we are well positioned to benefit from a sales recovery in distribution by capitalizing on our three platform strategy which enables us to provide exceptional value proposition to our customers. Now I would like to turn it over to Rob Starr to provide you with some additional details and color. Rob?

Thank you, Neal, and good morning everyone. As Neal indicated we are pleased with our results for the third quarter , which produced a 26% increase in consolidating operating profit on 3.5% higher sales as compared with the third quarter 2012. These results demonstrate our discipline on expenses, the operating leverage inherent in our business and the benefits of our diversified product portfolio.

Now I would like to provide you with some additional color on the numbers and our expectations. Within Aerospace we delivered solid execution across the segment while we expect our operational performance to remain strong we anticipate our future product mix will change somewhat. As we move forward our expectations is for sales of Aerospace build to print work to ramp up as we enter into full rate production on a number of our start up programs Neal had referenced earlier.

These programs, which tend to generate a lower return on sales than segment average will place some downward pressure on our overall Aerospace operating margin percentage. These programs despite having a lower margin provide earnings accretion, cash generation and solid return on investment. In Aerospace our backlog remains solid ending the quarter at $656 million an increase of 22% since year end. Recent significant bookings include the SH-2G (I) contract and several JPF awards. We have also booked awards of numerous smaller programs, such as Bearing programs the P-8 and CH-47 for Boeing.

Distribution recorded an operating margin of 5.4% in the third quarter representing improvement sequentially and over the prior year. Profit improvement was broad based as a result of leverage from higher sales which were a record in September and continued operating leverage as a result of our Q1 restructuring efforts. We are also accruing early benefits from our diversification efforts and our three platform strategy as evidenced by a strong performance in the quarter from our electrical and automation product lines. Margin also benefited from the reduction of certain incentive accruals. Offsetting some of this improvements were issues with Mexican mining projects and pressure on vendor volume incentives. Our free cash flow generation has been strong, generating $41 million in the last two quarters even after spending $18 million in capital expenditures. The organization is focused on improving cash flow and we have taken a number of actions to ensure we meet our objectives.

Moving on to our outlook we are revising the estimates to reflect our current view of the business environment. At distribution while growth rates are improving they are not achieving the levels we expected when we last spoke. This has caused to temper our full year sales outlook. Lower predicted sales levels will negatively impact our operating leverage and will lower volume incentives from our suppliers. At Aerospace we have slightly lowered and narrowed our sales estimates to reflect our current view of the business environment. This reflects our routine ships and the timing of deliveries and revenue recognition.

The operating margin outlook has been raised to a range of 16.8% to 17% reflecting stronger than expected year-to-date margin performance which we anticipate will be sustained. As we refine our estimates for the full year we know expect corporate expenses to come in the below our original estimates. We are projecting our full year tax rate will also be lower than previously anticipated at 34.5%, reflecting a lower statutory rate in the U.K. and favorable (Inaudible) from our filing of our 2012 return this past September. We are maintaining our full year free cash flow outlook at $16 million to $20 million. This reflects our expectations for continued investment in capital expenditures across the Company and working capital for new Aerospace programs. Overall we are pleased with our sales to date and we are focused on delivering stronger results.

With that, I will turn it back over to Neal. Neal?

Thanks, Rob. Overall we delivered strong results from the third quarter. We have benefited from the successful execution of strategies across our segment and remain confident that we will continue to deliver improved operational performance. I would also like to take this opportunity to thank all of Kaman's employees for their hard work and dedication. Their efforts have enabled Kaman to reach this new level of performance. With that, I will turn the call back over to Eric. Eric?

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

Thank you. (Operator Instructions). Our first question is from the line of Arnie Ursaner from CJS Securities . Arnie, your line is open. Please go ahead.

Hi, good morning. Thank you. My question relates to the impact of the SH-2G program on your margin and revenue in the quarter. You did indicate it was somewhat a key contributor. Can you quantify the impact of that for us and remind us if it will have an impact in Q4?

Sure. Hi, Arnie, it is Rob. The SH-2 did have a slightly above segment average impact. As we mentioned we are expected to deliver around $20 million of revenue from that program for the year and we remain on track to deliver that. So I think it is roughly about four or five points higher than our segment average.

How much was the revenue contribution in Q3 off the $20 million?

Sure. It was approximately $5 million for the quarter.

So you expect a similar amount in Q4?

Similar maybe slightly more in Q4 but not much. (Inaudible).

And similar margin?

Yes.

Okay. And Rob, I know when you spent some time with me you tried to highlight some of the working capital impacts when you start up new programs and you did mention the AH-1Z actually had its first delivery early this month, so as we think about Q4 can you remind us the capital investment you make when you have a new program running forward and how that may change now that this is moving into full program?

Sure. I would highlight a couple of things here, Arnie. You are absolutely right. In particular with AH-1Z we have invested significantly in start up working capital and with the delivery of our first cabin in the fourth quarter we would expect to see some relief in our working capital related specifically to that program. But it is not going to be all that material in the fourth quarter and largely because we are ramping up a number of other production units. We expect deliver hopefully another two units in the fourth quarter. But as we enter full rate production as we consistently generated cash flow relating to the sales we would expect over the course of over the next , let's call it, 6 months to 12 months to see some meaningful reduction in our AH-1Z inventory.

Thank you very much.

Thank you. (Operator Instructions). Next question is from the line of Matt Duncan from Stephens Incorporation. Please go ahead, Matt.

Good morning guys.

Good morning, Matt.

First question I have is with regards to the trends you are seeing at KIT, and ,Neal , you touched on this. You said that those sales flipped into positive territory on an organic basis in September. Can you walk us through the month-to-month growth rates that you saw there? How much was September up and what are you seeing in October?

Sure, Matt. It is actually a really good question because as you remembering during our last call we were actually seeing some positive trends in July. However after the call that turned down and August was bad as well. In fact, we were a little bit more than 5% negative organic growth in both July and in August. That turned around where we were positive 5% in September which we were really pleased with. We don't have final numbers yet for October, but to date we are running between 3% and 4% positive.

Okay. And did the comp get easier there in September, Neal, or was that actually demand and volume improvement or was it a little bit of both?

I think it was a little bit of both.

Matt, it was a bit of both in September.

Okay. Rob, on the SG&A cost they were down about $3 million sequentially. You mentioned there was some benefit in the quarter on variable comp accruals or did you actually reverse some accrual from earlier in the year or did the amount of the comp accrual just go down?

As we adjust our full year outlook we did make some downward estimates in terms of our overall incentive comp numbers.

How much did that reversal lower your SG&A expense by in the quarter?

I would say that was a portion of the reduction. There are other expense control initiatives in place as well, Matt.

Sure . But just on that one item do you know off the top of your head how much it was?

I would say it was not all of it but certainly a meaningful portion of that reduction.

So call it $2 million or so of the sequential drop in SG&A; is that fair?

It is not unfair, but I think it is one of those estimates that is going to change as we go through the rest of the year as we look through the full year number. But, yes, in the third quarter that is not an unfair estimate.

Okay. One more than I will jump back in queue. In terms of your operating margin at your Aerospace segment it has obviously been bouncing around a b lot, and if I look at your guidance for the full year it implies it is going to be probably 15.5% give or take in the fourth quarter it is going to be 16.8% to 17%, for the full year. Can you give us some help as we look out to next year. Once these programs ramp up and the mix settles in for that segment where you think it is going to be, what type of operating margin should we be using for the segment. I know you have not given guidance for next year yet, but given how much the margin has been moving around there I think there is a lot of questions about where that margin is headed in the future.

Matt, I would start by saying we set an objective for the Aerospace upper teens operating margin and over time that is a range that we are comfortable with. You are exactly right we had some bouncing around this year driven by a couple of factors. It primarily been deferral or later shipments in the year than we anticipated on AH-1Z and some of the other start up programs as Rob said in his prepared comments, our build to print work with lower margins. As those have moved out into the fourth quarter now and also we had some pull ins by other customers for our Specialty Bearing product line and some of the Egyptian helicopter upgrade program as well which are at higher margins that has really exacerbated that switch from quarter-to-quarter in margins that you see especially from the third quarter going into the fourth quarter. But I think we are comfortable with the high teens operating margin in that operating segment.

So 17% to 19% would be how you would define high teens then?

Some times we go 16.5% but that is probably not a bad range, Matt.

Okay. Thanks for the help. I appreciate it.

I'll go check your model.

Your next question is from the line of Edward Marshall from Sidoti & Company . Please go ahead.

Good morning, guys. Just two quick question. One, I wanted to get your opinion and maybe your outlook on how any defense sequestration, et cetera, not necessarily on the programs because I think you have covered that before, but more importantly on how the cash flow outlook works with that. I assume you turns will slow just a bit and maybe how you might be preparing for any kind of slow down there?

I will let Rob chime in. I don't think sequestration is going to impact us as much from a cash flow perspective. Where we were more concerned about that actually, Ed, was with the furloughs of government workers. The people weren't at work to actually pay the bills and that turned out not to be a problem for us because it was a relatively short time frame. But we had DCMA inspectors that were not coming into the plant to sign off on the final delivers for example for either a Z if we were doing Z or for UH-60. And then DFIS which is the funding source out of the government, the office that actually pay s the bills, they were on furlough as well. So I do not think sequestration will be as much an impact from a cash flow other than the program impacts that we have talked about.

I would concur with that, Ed. A couple of things we are taking a number of very specific actions across our Aerospace units in particular at managing our inventory levels relative to the demand. Part of the reason we have generated quite a bit cash flow in the back year is a number of those initiatives are beginning to take effect. In terms of sequestration in terms of some of the start up programs that is really where our cash flow challenges has been is really more on the start up programs than specifically related to sequestration.

Did the furloughs have any type of impact or push out push to the right in third quarter?

They did not in the third quarter because that really happened, Ed, on October 1st. We did have some slow downs in the first couple of weeks of October. Right now we are hoping to be able to make that up in the quarter, but a lot will depend on our end customers as to whether or not they are able to receive equipment from us. Because we don't know how much their lives have been back up since they didn't have DCMA in for inspections.

As we look at the pension rolling into 2014. Obviously there is going to be some adjustments there with the change of rates. Would you care to take a stab at it as to what kind of benefit or tailwind you may receive from the pension?

Sure. We are certainly benefiting from the higher discount rates, Ed, but what I would also point out is our investment strategy on our pension does incorporate what is known as a liability driven investment strategy. So relative to some of your traditional strategies , your normal 60/40 we are not going to see as much benefit as a traditional 60/40, but I expect to see our pension expense come down next year probably somewhere in the range of 20% to 25%.

And what is that expense number this year?

Approximately $8 million.

Thanks, guys.

Thank you, Ed.

Our next question is from Jeff Hammond of KeyBanc Capital Markets . Please go ahead.

Good morning , guys.

Good morning, Jeff.

I know you are not giving guidance but you tend to have better visibility in the Aerospace business. Can you talk about what you see as some key puts and takes whether it be programs or just trends in commercial, military as you look in to 2014? And then coming back to margin comment I just want to be clear if these ramp issues are 4Q issue or 2014 issue as well?

I will start with that one, Jeff. We will break it down and do it three components parts from the Aerospace side on the aircraft side to begin with. Commercial we still see as strong through next year. Now I think we seen the first couple of steps off from the 787 ramp up , so I would expect that we are not going to see within our Specialty Bearings business a big tick up from 787 next year. I think they are at the rate level now.

Now late in 2014 we might or in 2015 as they ramp up to know what they are saying is going to be 12 aircraft a month. But I think we see 787 is relatively consistent from year-to-year. Tick up hopefully with A350 later in the year but that would be later in the year. And I that sums up another strong slight growth in the commercial aircraft until A350 hits in stride out into 2015. Business aircraft frankly we still see as depressed , and we would love to see that tick back , but we don't see that yet.

And then on the military aircraft side without getting too program specific, I think we all know C-17 is going to come to an end. We have deliveries that will take us through mid to late 2014, so we don't see much impact on that in 2014. We might be flattish on UH-60 Probably no growth there but AH-60 ticking up and maybe slight growth in A-10. But that is really how we see the markets sizing up for next year.

And then on the ramp -- I guess the one other thing SH-2G (I) tick up for us next year. We will tell you what that is going to be on our next call, but we will obviously see that tick up. Finally on your question about the ramp rate obviously fourth quarter we are going to have early deliveries lower than segment margins. We would expect that those early deliveries probably through 2014 are going to continue with those lower margin contribution rates until we get to full rate production probably in 2015. But we will talk more about that on the next call.

Just one more. Maybe just touch on how you are thinking JPF and visibility and on the same lines into 2014 and maybe customer mix?

Right now we have more than a year of backlog so we feel good about that. I think it is just over $130 million so we are good there. We would expect that we will have a much higher mix of U.S. G sales next year. As you know we have had high percentage of direct commercial sales that are very profitable for us this year, that is what has enabled us to stay constant or approximately constant on profit contribution from that product line despite much lower unit volume from year to year. But we will probably go back towards a more normalized trend of much higher percentage of U.S. G sales.

Thanks , guys. I will get back in queue.

Thanks, Jeff.

Next question from the line of Steven Levenson from Stifel . Please go ahead.

Thanks. Good morning, everybody.

Good morning, Steve.

Neal, you mentioned some new Aerospace programs. you are getting unprecedented levels. I know one of your press releases was about the Scorpion, and I was going to ask you to comment on what you think the opportunity is there and what the risks given it is a new plane and there basically are not any orders for it and how you decided to go into that and if there are any comparable ones or if the others one are different? Sorry multi part question. Thanks.

That is okay. First of all , I give enormous credit to Textron for going off and taking this on. I think we all know that other than this aircraft which people didn't know about there was really no manned fighter aircraft or manned aircraft under development by the U.S. Department of Defense since the first time since it was established. So I give Textron an enormous amount of credit in stepping out and taking on this development. I think the way they have done it has been very thoughtful as well. I think that is what really drove us to team with them. We think Scott Donnelly and his team are very, very smart guys frankly. They saw an opportunity to put an aircraft out in the market that meets the needs for a broad range of missions and is going to be very cost effective. Certainly there is risk. We have teamed with them on this program. We feel it provides an opportunity, and we are going to do everything we can to help them be successful.

And are others programs that haven't been named yet maybe you can't name them are they similar to this or are they more along the line of say AH-1Z where there is demand for the product?

Steve, I'm afraid I'm not clear on that part of the question.

Are the other programs you are involved in among the unprecedented number of new programs you are working on more similar to Scorpion or more similar to other aircraft?

I'm sorry. More similar to the named aircraft that are out in the domain today. The biggest by far is AH-1Z for Bell and another Textron Company. I'll be down there again on Thursday of this week, but we have about eight aircraft in process right now and certainly in our detail fab. shop well past probably aircraft 12. So that is the build up of inventory there. And then also on Lear 85 and the G280 those are the main new start up programs that we are investing on but are going to do very well for us through 2014 and 2015

Great. Thank you very much.

Thanks, Steve.

Next question comes from the line of Eli Lustgarten from Longbow Securities . Please go ahead.

Good morning, everyone.

Good morning, Eli.

I have one follow-up on Aerospace. During your commentary, you talked about first half of this year having some Specialty Bearings business, I believe, that helped profitability and then you also talked about some direct sales on the Aerospace programs that also helped profitability. The two factors suggested that we could have difficult comps in 2014 versus 2013 in the Aerospace profitability, at least in the first half versus first half if not for the whole year. Can you give us some color on how we should think about it as we go through into 2014?

I think that, Eli, you are right. We will have some tough comparative periods. The mix that we have talked about there is that in 2013, we had lower USG demand and therefore, much higher direct commercial sales of our JPF product line, and we do sell at higher prices for direct commercial sales. So yes, that will provide some headwind as we look at 2014 versus 2013. And also, we did have a number of retrofit and other programs in our Specialty Bearings product lines for things like have helicopter drive shafts and other things that happened to land in the first half of the year as well. So we will have some tough comps. We have a business that is growing. We continue to make operational improvements, so we'll deals with those tougher comps.

So expectations is that you will still have improved profitability in 2014 versus 2013 even despite these headwinds.

I think we are still refining our 2014 numbers, Eli. So we'll certainly address that on our next call.

Okay. Can we talk a little bit about what's going on in the Distribution business. OEM, as you say, are a very weak. Could you give us some idea whether inventory destocking or restocking, what's going on across the board by your customers? Are they finally starting to normalize their holdings? And can you give us some insight as to what you are seeing in the fourth quarter after the shock we got out of the Timken numbers in the bearing and power transmission numbers, nobody's quite sure what's going on in the marketplace.

I think what we are seeing with our OEM customer base is certainly a reevaluation of global market conditions. If you look at Caterpillar's numbers, certainly Timken is being affected by that and we are seeing that in our direct OEM customer base, a softening. there is no question. Could you repeat the second part of your question, Eli?

I'm just trying to get an idea of what you are seeing as you go to the end of the year, across the end market as I said, because the implication of the numbers were things are getting softer almost power transition markets, you show us a little bit different characteristics with the strength of that non-OEM business. I'm just trying to get a sense of what you are seeing in the fourth quarter from your end markets in the bearing business.

Actually, specific to the Timken comment, if you look at our bearing product line sales, they're down but they are down low single digits, so not as much a number of the new OEMs have talked about. And actually, as we look at our market sequentially, Eli, of our top 10 markets, 6 were up and 4 were down so that was actually an improvement for us from our first to second quarter mix. So we are getting a little bit of underlying improvement. Actually, mining for us was up fractionally so that was a nice change for us. Primary metals were up. Transportations were up. The areas that were down for us were OEM machinery and more so in our traditional power transmission and motion control product lines. We had a very strong performance for OEMs in our electrical and automation platform.

Paper is down for us quite a bit. Fabricated metals are down for us as well. But the other thing that we highlighted in our prepared remarks, Eli, is that we have had a significant amount of weakness in our Mexican operations. And also, we entered into a number of fixed price mining contracts. And quite frankly, we were not as experienced as we are today in those, from either how we bid them or from a project management perspective. So we are in the learning curve, if I can be kind there, and that is impacting us as well in the third quarter, and we expect some negative impact in the fourth quarter.

And, Eli, just one other point I would like to make in terms of the overall reduction in our sales guidance for Distribution. That really does reflect the softer economy than we had anticipated there in the second quarter of our call, consistent with what you are seeing whether it be from Timken or others that have announced.

Thank you very much.

Thank you.

Thank you. (Operator Instructions). Next question is from the line of Bhupender Bohra from Jefferies.

Scott Graham here. The first question on Industrial Distribution, we are seeing, like you mentioned, September was up mid-single digit. And then if I look at the guidance, actually, it tells me the operating margin guidance was taken down so that implies like 4Q guidance was, on the margin side for us, is low. Could you tell us what is driving that?

Sure. Hope you are well Bhupender. Certainly, there are a few key items that are driving our reduced outlook for margin in the fourth quarter. In particular, to what Neal just commented on, the challenges that we are having in Mexico, that will have an impact on the fourth quarter as we looking to close out those mining contracts. There was also increased pressure on vendor rebates as we are managing our cash flow correctly in lower sales volume, that will put additional pressure relating to that. And we are also just being a little bit cautious given the government shutdown during October and what impact it might have in the broader economy. So a combination of those factors is really what's driving our margin guidance down.

Okay. How big is the Mexico mining thing? Is it a big factor in terms of sales or margin wise?

The impact is more on the margin side. As Neal mentioned, we were somewhat inexperienced in bidding out these contracts. So I'm really not at liberty to say how much the impact is, but it's certainly enough to make comment here on the call.

Okay. And the next question is on the same line basically. You guys talked about the 3-tier structure on the 3 platforms, basically, in KIT. Could you elaborate like how those 3 platforms did actually performed during the quarter? If you could give us some color on that?

Sure. At a very top level, Bhupender, the primary weakness that we had was in our legacy power transmission motion control product lines, and I think that is very consistent with what you would have seen both from other comparable distribution companies or certainly from the bearing and power transmission manufacturers that have reported as well. And I think we are very pleased with the progress we have made, both in our fluid power product lines, as well as our electrical and automation product lines. that is really what enabled us to flip over to positive growth in September.

Okay. And a follow-up on actually on the M&A pipeline. If you could give us a color on the M&A pipeline with respect to your distribution business, which of these platforms still remains your priority going forward?

Bhupender, it's a really good question. I hope what you've seen from the acquisitions that we have completed is that we have a primary focus in building out our fluid power relationship and geographic footprint with Parker. We certainly are keenly interested in continuing to grow our electrical and automation platform, really with the foundation of Minarik and Zeller, we have a great capability there and a great management team that we know can effectively integrate acquisitions and grow. And at the same time, when you look at an acquisition like Ohio Gear & Transmission, we still want to invest in areas where we have not had a strong geographic presence before, be able to establish that footprint with a power transmission motion control acquisition and then augment it with additional fluid power and electrical and automation capabilities to get that synergy sale.

Thanks a lot.

Thank you. Next question is from the line of Matt Duncan from Stephens Inc. Please go ahead, Matt.

This is just a follow-up to that last question on the M&A side. It looks like based on the corporate expense guidance for the year that those costs are going to jump a couple of million dollars in the fourth quarter. Does that suggest maybe you guys are getting a little bit more active on the M&A front here in the short run?

that is typically one of the expense items that ebbs and flows by quarter. So that is not an unfair conclusion to draw.

Yes. Matt, I would also point out, not unlike other companies we are seeing year-over-year increases in our medical expense. And that would also be reflected in corporate year.

Okay. Neal, the size of M&A opportunities that are out there. Are you seeing larger ones or are they still in the smaller range or is most of what's coming across the (Inaudible)?

Matt, we have seen a couple larger ones. We would like to do a larger one in Distribution. And certainly, what you are seeing characterized, at least since we did Zeller last year. It just comes down to the fact that when you look simply at a number of ones that are out there, they are typically smaller. The ones that we have done recently are a little bit smaller than we would typically do. However, it really has helped us dramatically increase the number of Parker stores that we have in our lineup today, which is obviously, very important to us strategically. we are going to be very cautious on the larger ones given, just frankly, the uncertainty that we see out in the marketplace. But we also feel that the management team that we have in place has done a pretty good job in assessing those acquisitions.

Okay. And then a couple of questions on the outlook here for KIT. So I guess October is up 3% or 4%. I'm trying to remember, did Sandy hurt you guys last year just given where you are located?

I don't think it really hurt us in any meaningful way. We were able to automatically reroute calls and serve customers from other locations. We obviously had some shutdown of customers. We actually assessed that and it really didn't move the needle very much for us.

Okay. So if I look at the guidance for the year, it implies that you probably need about 5% to 10% organic growth rate at KIT in the fourth quarter to get to the guidance. And I think you got an extra selling days, so that is probably part of how you get from 3% to 4% in October up to that 5% to 10% range. But are you counting on some underlying demand improvement going forward or is it just the easier comp that gets you to that growth level?

Matt, it's really a bit of both, but I would say the comps in Q4 do get easier relative to last year as a recall, we had a very challenging fourth quarter in 2012. But we are looking for continued, granted, slow improvement in underlying economic growth that should translate into improved sales.

Okay. And then last thing on the KIT margin. It sounds like the reversal of variable comp accruals helped a couple of million dollars in the quarter, so if I adjust your operating margin for that, you are in the 4.6, 4.7 range. And that is pretty close to what you are guiding to for the fourth quarter. And again, I know it is a little early to be talking about next year but, I know, Neal, a couple of years ago, when you laid out 2014 goals, the operating margin hope was certainly above where you are at right now. I think it was 7% that you were trying to get to. How quickly do now think you can get up to that level from where you are?

Matt, what I'd prefer to do is that we'll talk about the when we do our fourth quarter call because you are right, we had a 7% target for 2014. And given lower GDP growth since 2009, we came out of the recovery, we and I think others felt that we would have a stronger underlying level of GDP growth than we have encountered. We also expected that we would have more acquisition contribution as well. So we are going to fall short on the top line. we are going to fall short on the margin. we are confident that we are going to be able to make significant improvement from 2013 to 2014. But we also understand that we need to invest in this business to drive some improvement in that top line growth. So those are some of the discussions and analysis that we are going through right now, that we'll talk more about after the year is complete.

Obviously, I get that you need a better economy to get a sort of margin improvement that you there and maybe another way to think about this is what level of organic revenue growth do you need to drive 50 to 100 basis points of operating margin expansion in the year. Because a big part of it is you have to grow that business organically to get leverage.

We would agree. I mean organic growth is very critical to achieving our margin targets. Matt, I just want to address your comment regarding the incentive comp in the quarter for Distribution. The $2 million we were talking to, which was an estimate, really, was an overall comp. And keep in mind, our incentive comp numbers did come down at corporate as well. So I want to be clear.

Okay, that helps, Rob.

We have a number of give and takes within distribution, of which incentive comp was one of them.

Okay, that is helpful. Thank you for that clarification.

Sure. I just want to make sure that we are all on the same page. Thank you.

Thank you. Our last question comes from the line of Jeff Hammond from KeyBanc Capital Markets. Please go ahead.

Hi, guys. Just in your queue, you mentioned a couple of dynamics in a few of your acquired businesses over the last few years. Can you just expound on what's going on there and how we should think about goodwill impacts, et cetera?

Sure. I'll start, Jeff. I think that we are in the early stages of our goodwill analysis, which we do each year. I think, in fact, if you look at our third quarter queue from last year, you would have seen some similar language for both our U.K. acquisition and our Vermont acquisition. I think what's probably new this year is the language around going to the Global Aerosystems acquisition. And quite frankly, the reductions in Boeing's external engineering resources over the course of last year has been pretty dramatic, on a percentage of almost 50%. So that is been a significant impact for us from year-to-year.

Boeing, as we work with Boeing, we continued to feel encouraged that as they announce to begin development of the 777X, there is going to be a significant demand for our engineering services. And , in fact, we expect to be able to effectively leverage our selection as supplier of the year, for that business at Boeing last year. But that is really the new one and the one where we have had the most significant change from year-to-year.

In some of our other businesses, obviously, as we have experienced pushouts on things like everything from a Joint Strike Fighter, when we acquired the U.K. business some 5 years ago, we thought that we would be at much higher production rates for the JSF. That impacts us. Also, P-8 and B-22 are at lower levels than had been anticipated either by Textran or by Boeing when we made those acquisition a number of years ago. So those are the things that all go into the analysis. But I would say the one thing that is really different from year-to-year is the engineering systems one.

Okay. And then a quick follow-up on Distribution. Given that we have kind of persistently sluggish environment, can you talk about what you are seeing on the competitive front? How you are seeing price cost or point-of-sale pricing and how that is impacting or not impacting the margin trajectory?

Jeff, I think that we have seen margin pressure. I think one of our larger competitors actually commented about that recently. Obviously, everybody's trying to grow their business, and at times, part of that comes at the expense of margin. we are trying really very hard to manage that because that is a very slippery slope, as you know. But I think certainly there is been margin pressure from year-to-year that is impacted the industry overall.

Thanks, guys.

Thank you, Jeff.

Thank you. We have no questions in the queue. Should we conclude the call?

Yes. Thank you, Bhupender, and thank you everybody for joining us today. We look forward to speaking to you again when report our fourth quarter and full year results in February.

Ladies and gentlemen, that concludes your call for today. Thank you for joining. You may now disconnect.