Kaman Corp (KAMN) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, welcome to Kaman Corporation third-quarter 2014 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Mr. Eric Remington, Vice President Investor Relations. Please proceed.

Thank you. Good morning. Welcome to the Kaman Corporation third-quarter 2014 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 2013 annual report on Form 10-K and the current report on Form 8-K filed yesterday evening together with our earnings release.

In addition, in our press release and on this teleconference we'll discuss certain financial measures and information that are non-GAAP financial measures. Reconciliations to comparable GAAP measures is included in the tables of our press release, which has been filed with the SEC and posted in the investor relations section of our website which can be accessed at the www.Kaman.com.

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

Thank you, Eric. Good morning, and thank you for joining us today. Overall, diluted earnings per share in the third quarter were $0.60 adjusted. Our performance was driven by aerospace, which once again delivered strong margins. While at distribution, we continued to implement our growth initiatives including the addition of new sales resources and the initial rollout of our new ERP system.

While these initiatives had an impact on profitability, they are important elements of our strategy to achieve higher, more sustainable margins over the longer term. Through focused working capital initiatives, we delivered strong, free cash flow for the quarter, allowing us to raise our free cash flow outlook for the year.

Looking at each of our segments beginning with aerospace, we achieved year-over-year sales growth of 2% despite a challenging macro environment that included the wind-down of the C17 and Egyptian SHQ upgrade programs in addition to lower sales of Black Hawk cockpits.

These sales declines were more than offset by increased revenue recognized under the AH-1Z cabin program, initial deliveries of the 747-8 wing to body fairings, higher A-10 shipments and contributions from the New Zealand SH-2G(I) program.

Our specialty bearing product lines continued their strong performance. While we experienced lower year-over-year sales of marine bearings, this was offset by higher deliveries for regional and business jets.

Overall orders for bearing products are up more than 10% for the full year, driven by commercial aircraft platforms including the A350, supporting our expectations for solid growth over the medium term.

We are very pleased with the progress of our new facility in Germany and saw a nice improvement this quarter and expect further progress in the fourth quarter. I'm proud of our team in Germany. They've done a very good job transitioning into our new facility and have successfully worked through the required first article of recertification processes with our customers.

The New Zealand SH2 program continues to perform well and contributed to sales and profit in the quarter. We currently have about two dozen New Zealand personnel on site here in Bloomfield in preparation for the acceptance of the first three aircraft later this month. And we expect this program will continue through the third quarter of next year.

Last week, we confirmed the news that New Zealand's existing aircraft will be remanufactured and upgraded for delivery to the Peruvian Navy under a contract with General Dynamics Canada. The Peruvian program will provide additional SH2 revenue as we complete the New Zealand program, as well as providing additional long-term service and support revenues. In fact, upon delivery of the SH-2G(I)s to New Zealand and the five aircraft to Peru, the SH2 flying fleet will have grown by more than 40%.

In addition to the Peruvian contract, we have been negotiating a number of new contracts which have been awarded or are in the late stages of negotiations, including a three-year extension of our contract with Bell to remain their premier supplier of commercial rotor blade components. An extension of our contract with Boeing to supply fixed trailing edges for the 777 and 767 aircraft. This contract will also cover the 767 derivative KC-46 tanker.

An award from Rolls-Royce, an important new direct customer for composite structures on the engine for the A350. A jet -- additional JPF orders under our Air Force contract. A foreign military sale contract for JPF fuses that was filled on an emergency basis due to an urgent customer requirement. And a contract to repair the Marine Corp's unmanned K-MAX that was damaged in Afghanistan.

In addition to these program wins, bid activity remains high as we continue to pursue new organic growth opportunities across the aerospace segment.

Shifting to distribution, sales were up 13% over the prior year to a record $308.6 million. The third quarter was our first with three months' contribution from the acquisition of BW Rogers and resulted in our highest consolidated growth rate since the second quarter of 2011.

Organic sales growth trends through mid-September were favorable. However, we experienced significantly weaker sales in late September, reducing our organic growth for the quarter to 1.7%. Breaking down the organic growth for the quarter a bit further, our domestic KIT business was up 5% year over year, and our fluid power business was up 6%. However, we experienced year-over-year declines in our Zeller and Minarik businesses as well as in Mexico. A portion of the decline in the Minarik business was attributable to the inefficiencies we encountered as we transitioned to our new ERP system.

Moving to end markets, overall for the quarter we experienced sales growth in our OEM machine builder and transportation equipment end markets. However, we experienced relative weakness in mining and chemical manufacturing end markets, but continue to see opportunities in the marketplace and were encouraged that sales trended up sequentially mid-single digits in October.

Before turning the call over to Rob, I'd like to leave you with these closing thoughts. Although we had some challenges in the third quarter, we believe we've made substantial progress toward the strategic objectives presented during our investor day. In aerospace, our new business pipeline under the one-command initiative is getting traction in the marketplace and has resulted in the highest level of bid activity in our history. The successful negotiation of the Peru SH-2 program will provide a nice bridge as we complete the New Zealand program next year. This, along with the ramp-up of new programs such as the A350, provides visibility as we head into 2015.

In distribution, we faced headwinds from a number of discrete items that impacted our results for the quarter. Many of these relate to our growth initiatives, which are critical to achieving our margin objectives over the long term. With that, I will turn the call over to Rob for some comments on the financials.

Thank you, Neal, and good morning, everyone. I'd like to begin this morning by reviewing our results before moving to our revised 2014 outlook. On a consolidated level, GAAP earnings per share from continuing operations was $0.53 in the quarter, with adjusted earnings per share at $0.60 after adjusting for the costs associated with the sale of our [Musit] facility and restructuring charges at distribution.

The $0.08 decrease in adjusted earnings relative to the prior year was driven by a number of factors including unfavorable product mix changes at aerospace and the near-term impact of our growth initiatives at distribution.

I want to spend a minute on our SG&A expenses, as a number of items have impacted the comparability of our results with the prior year. For the third quarter, our reported SG&A expenses as a percentage of sales was 22.4%, 180 basis points higher than the prior year. Acquisitions, ERP depreciation, the musit charge and severance costs of distribution negatively impacted our SG&A ratio by 90 basis points for the quarter.

For the year to date period, our reported SG&A expenses as a percentage of sales was also 22.4%, 40 basis points higher than the prior year. Acquisitions, ERP depreciation, the musit charge and severance cost of distribution negatively impacted our SG&A expense ratio by 30 basis points for the year-to-date period.

In absolute terms, our year-to-date SG&A expense adjusted for the previously mentioned items has increased by $7.2 million, or 2.6%.

Free cash flow performance in the quarter was very strong at $27.5 million as we continued our disciplined focus on improving working capital metrics. For the year-to-date period, we generated $21.3 million in free cash flow and are $26.6 million ahead of last year's results.

Taking a closer look at segment performance beginning at aerospace, we achieved sales of $154 million, a 2% increase over the prior year, and achieved our highest operating margin of the year at 17.4%. On a comparative basis, which is 90 basis points lower than the prior year largely as a result of a lower mix of direct commercial Joint Programmable Fuze deliveries and the wind-down of our Egyptian SH-2 DI upgrade program.

Our Engineered Services Group continues to experience near-term challenges which also impacted our third-quarter results. These headwinds were partially offset by higher profit on the New Zealand SH-2 DI program and improved performance at our composite programs. Our specialty bearing product lines continue to perform well, and they have seen strong order intakes, providing confidence for their future performance.

We have had a solid year to date result at aerospace, with revenues increasing 3% over the prior year to $458 million while delivering strong margin results. We have shipped increasing volumes of our Joint Programmable Fuzes; and a number of other programs including our SH-2 and 747-8 programs have ramped up during 2014, providing us offsetting growth as our Black Hawk deliveries have declined and our C-17 program has wound down. Operating margins year to date at aerospace is 16.5% compared to 17.4% in the prior year.

Impacting our year-to-date margins are the absence of the one-time retrofit bearing orders we benefited from last year and lower levels of direct commercial shipments for our Joint Programmable Fuzes to foreign customers.

Moving now to distribution, our third-quarter consolidated sales were a record $309 million, a 13% increase over the prior year largely driven by our recent acquisition of BW Rogers. Operating income for the quarter was $13.3 million, or 4.3% of sales -- 4.5% adjusted for severance costs incurred in the quarter. Compared to $14.7 million, or 5.4% of sales, in the prior year. Operating margin levels in the quarter were impacted by the previously referenced shortfall in sales, near-term net costs associated with our sales force initiatives, higher ERP expenses, as well as weaker-than-expected results at our Mexico operations.

As we have discussed on prior calls, we anticipate the costs associated with our new sales resources initiative to remain dilutive to margins through year end and expect that initiative to provide incremental benefits beginning next year.

Distributions year-to-date results have shown considerable progress when measured against the prior year. After adjusting for the severance costs we incurred in the third quarter, distributions year-to-date operating margin is 4.6%, a 50-basis-point improvement over the prior year. This result translates into a 22% increase in operating profit dollars on nearly 10% sales growth. On a same-store basis, our daily sales rate is up 2.2% in the year-to-date period, and our operating income dollars at distribution have increased by 11%.

Turning now to our outlook, we have made a number of adjustments based on our year-to-date performance and our visibility for the balance of the year. At aerospace, we are lowering our estimate for full-year sales to a range of $630 million to $640 million. This result is primarily from Aerosystems program push-outs, most notably on the Black Hawk cockpit, AH-1Z fuselage program and the Peru programs.

We are raising aerospace's operating income range to 16.8% to 17.0% to reflect change in the expected fourth-quarter sales mix. At the midpoint of our revised sales and operating margin outlook, the operating profit dollars for aerospace remain essentially unchanged from our previous outlook.

In distribution, we have tempered our view of near-term organic sales growth due to the jet project push-outs at our automation control and engine platforms, weaker-than-anticipated demand within the domestic mining sector and continued weakness at our Mexico operation. Accordingly, we have lowered our sales range slightly to $1.185 billion to $1.195 billion. Based upon our full-year results and our revised sales outlook, we have lowered our full-year operating income margin outlook to a range of 4.5% to 4.6% including the third-quarter severance charges.

In addition to the changes at the segment level, we are also lowering our outlook for corporate expense to $51 million from $52 million, reflecting our continued focus on expense control. I want to highlight this number excludes the $2.3 million charge taken in the third quarter relating to the sale of our former musit facility.

Our full-year tax rate is expected to be a full point lower than our previous outlook and should come in around 34%.

Finally, we have increased our full year of free cash flow expectations to a range of $55 million to $60 million. This represents a significant increase over our initial full-year guidance of $40 million to $45 million, reflecting our continued focus on improving cash flow performance.

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

Thanks, Rob. As I said earlier, we faced several challenges during the quarter but have also taken important steps forward. In distribution, we delivered double-digit consolidated growth, delivered our fourth consecutive quarter of positive organic growth while also implementing the first phase of our ERP conversion.

In aerospace, we were able to deliver continued organic growth despite reductions in the number of key programs, improved our operating margins on a sequential basis, completed our transitions into new facilities in Germany and the UK, and expect to finalize a contract in the near term that will significantly expand our SH-2 fleet.

And finally, we have been able to increase our full-year free cash flow outlook.

With that, I'll turn the call back over to Eric. Eric?

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

(Operator Instructions) Arnie Ursaner.

In your prepared remarks, you mentioned that the sales force build-out was dilutive to margin and will be through year end. Can you give us a sense of the margin headwind you are incurring in 2014 and how you're internally thinking about a margin goal for distribution from these added salespeople in 2015?

Sure. Good morning, Arnie. It's Rob. In taking a look at the sales force initiative in the third quarter, Arnie, that had an approximate 20-basis-point impact on the quarter. We expect that impact to certainly moderate in the fourth quarter while still being somewhat negative. And certainly as we enter 2015, as we talked about, we would expect that to provide incremental earnings as we go through 2015.

And any attempt at quantifying a margin goal for distribution for 2015?

Not at this time, Arnie. But certainly, I think it's fair to say that we expect this to generate incremental margin that we would anticipate being segment average. I really can't give a lot more than that.

Okay. And then, Neal, in your remarks, you highlighted domestic mining and Mexico were particularly weak in distribution. How far down were both of those?

Certainly. If it's okay (multiple speakers). In Mexico, Arnie, we experienced -- let's call it slightly double-digit declines in Mexico. And then in the domestic mining sector, it was weaker than expected but certainly a negative headwind for us relative to prior periods and our expectations.

Okay. I'll stop with those two questions. Thanks.

Jeff Hammond.

So maybe just to follow on Arnie's question about distribution margins, can you maybe just walk us through the number of what you think are one timers in 2014 that abate, whether it be this ERP issue, any kind of purchase accounting costs and maybe the sales force headwind? Because it seems like if all that goes away, you get maybe some nice snapback in the margins in 2015.

Sure. No, that's fair. Just taking a look at the main items here, Jeff, we'll start with the purchase accounting on BW Rogers. As we highlighted in the earlier call, we expected about $2.2 million in one-time charges this year relating to BW Rogers. About $1.5 million of that is transaction expenses, and about $1.7 million relates to the purchase accounting which would be inventory write-offs, things such as intangible amortization and so forth. So that's the purchase accounting for this year as it relates to BW Rogers.

Taking a look at the ERP impact in the quarter, we estimate that the top-line impact was approximately in the $5 million range. In terms of operating income impact for the quarter, we estimate that is somewhere between $1.5 million and $2 million. And would certainly -- would anticipate that in the fourth quarter we would expect to see some continued headwinds relating to ERP, although those numbers are difficult to gauge, as you can appreciate. But certainly, we would expect some further impact in the fourth quarter.

On the sales force initiative, we did have about a 20-basis-point headwind this quarter. We expect that to moderate in the fourth quarter before turning positive hopefully in 2015; that's our expectation.

I just want to point out, Jeff, that the acquisition costs relating to BW Rogers are being reflected in our corporate expense.

Okay, great. And then just to follow on, Neal, always a number of moving pieces, and you talked about a number of activities and potential wins in aero. Can you give us an early look on into 2015 on how you're kind of thinking about growth? Do we get catch-up from some of these push-outs? What's kind of the view on JPF? Some of the moving pieces on new programs and just maybe overall commercial?

Sure, Jeff. I think that we would remain consistent in our view of mid-single-digit organic growth in the aerospace business. As we did try to highlight in our prepared remarks, we have had both a number of program push-outs this year, which we expect we would catch up on during next year. We will also have the Peruvian contract coming in, which will certainly be positive.

And I know that even earlier today, as we had a chance to review your note, you highlighted some of the decline in backlog that we've encountered this year. I think that's clear, and it's a forward indicator of our business. I hope that in our prepared remarks, we were able to highlight a number of the issues -- or excuse me, a number of the contracts that we've either closed on since the end of the quarter or are very close to closing on, which will rebuild that backlog to more normalized levels.

For example, a portion of the Peru contract will come in. One of the big declines, quite frankly, has been as we have run off the 767, 777 fixed trailing-edge contract with Boeing, we are in the final stages of negotiating the extension of that, which would be a significant addition to our backlog. And also, as we continue with the AH-1Z, we currently are under contract for about 17 aircraft in our backlog, and we expect that to be a significant program for us as we negotiate add-on contracts for the Zulu aircraft with Bell.

Great. Thanks, guys.

Peter Skibitski.

I just wanted to understand better the reduction in Aerospace revenue guidance. You mentioned the US 60 -- or excuse me the UH-60, but I thought you left your delivery guidance intact at like 90 chipsets. And maybe you could talk about the AH-1Z in terms of how many chipsets you expect to deliver for 2014 versus your prior expectation.

Sure. Pete, we'll start with the AH-1Z. We do expect to ship during the course of the year approximately 8 to 10 cabins. That's relative to an expectation prior that was probably, let's call it, roughly 5 cabins more. Somewhere in that range based on our initial outlook for the year. So we're certainly seeing some slippage in terms of timing on AH-1Z.

On UH-60, you are correct that the amount that was disclosed remained consistent. We had some expectations perhaps of doing a slight bit better than that. And we realized now that we are pretty much at the firm 90 now that we have only a quarter to go. So relative to some of the expectations towards the higher end of our sales range, we felt that it would be appropriate to take that down a little bit.

We would also -- while, as you can imagine, Pete, we also had anticipated a little bit earlier conclusion of the Peruvian contract. As many times happens with government contracts, it gets delayed a little bit. We feel we are very close to finalizing that. But, quite frankly, that's arguably 30 to 45, maybe even 60 days later than we had anticipated four to six months ago. It's a program we've been working on for multiple years.

Understood. And one question on the free cash flow guidance also, clearly you need working capital to come through here in the fourth quarter. So maybe for Rob. Rob, is there anything you're kind of worried about out there on your free cash flow in the fourth quarter in terms of collections or any of the other items?

Yes, no. We have a couple of key milestones our SH-2 program with New Zealand that will drive a good portion of the cash flow we expect in the fourth quarter. And we feel that we are certainly in a good place relative to meeting those milestones. But certainly if something happened that we couldn't meet those milestones, that would impact cash flow results that we expect in the fourth quarter.

But short of that, our distribution, they're doing a terrific job at managing their working capital levels and elsewhere in aerospace. People are focused on it. Certainly, you know, we've had even a slight reduction, as you would expect, on our AH-1Z inventory quarter over quarter.

So we are starting to turn the tide there. That has been a major consumption of working capital as it relates to that program in particular. So, no, we feel pretty good about it, but certainly is going to come down to meeting the milestones on our New Zealand contract.

Okay. Got it. And I promise one last question. On the cash spend for the ERP distribution, I just want to make sure I'm reading your 10-Q right. It looks like total cost is $45 million, and you've already paid out $28 million of that. So I'm just wondering when the final $17 million payment comes. Is that all paid out by the end of 2015, or does it go longer? Because I'm just thinking it looks like it could be a cash tailwind for you going forward as it runs off.

Certainly. No, you are correct in your understanding, Pete. We have spent $28 million of the expected $45 million relating to the distribution of ERP. That is not going to all happen in 2015. Some of that spend will go into 2016 as we roll it out.

And that will be the last year, 2016?

We'll see. We would expect that certainly as it relates to the initial implementation, which is the initial scope of the project. Yes, we would expect that to roll off certainly by 2016.

Okay. Thanks, guys.

Matt Duncan.

Neal, you said that the organic sales growth rate at KIT was trending pretty nicely mid-September, then it tailed off when you went live on the ERP install. Can you quantify that for us? How much higher was it running than the 1.7% that you reported?

Matt, I want to take a step back, first of all. We actually went live on our ERP at the beginning of the third quarter. So the decline in orders that we saw in the last two weeks of September was not directly correlated to the ERP go-live. So I want to make sure that that's clear to begin with.

But, Matt, it was really -- it was interesting because we were running at about a 3%, maybe a little bit better than that percent growth rate for the quarter, and we saw that turn from about a plus 7.5% for the month down to a minus 2.5% in the last two weeks. So it was a very dramatic change, and it was something we hadn't anticipated. I know one of our other competitors encountered something similar. It was relatively broad-based for us in arguably three of our five reporting regions. So we can't pin it on any one area particularly, although mining in the Intermountain region was probably the largest decline.

And then also, as we commented, we had a nice return to mid-single-digit growth in the month of October. So I don't know that we have a very sound explanation as to why we had the kind of tail-off in that two-week period of time as we experienced.

And that mid-single digit October, Neal, that's year over year, right?

That's correct.

Okay. Yes, it's interesting that that seems odd.

Okay, moving on to the aerospace side. Rob, I just want to make sure I understand the puts and takes here. It looks like you guys are expecting somewhere around $180 million in aerospace revenues in the fourth quarter. Obviously, you've got free deliveries of SH-2G to New Zealand that are helping that number.

But as we look out to next year and are trying to think through a reasonable quarterly run rate for those revenues, you're going to continue to deliver to New Zealand through it sounds like the third quarter of next year.

So do we need to be thinking around that maybe 1.75 to 1.80 range for the first three quarters and then it off? Or is it -- just help us understand is there anything else that is helping the 4Q that is sort of one time? I just want to make sure we get this dialed in a little bit before we get to the guide for next year.

Yes, no. Fair enough. And clearly, we'll provide our 2015 outlook on the February call. Certainly, you are absolutely right, Matt, that the math works out that we are expecting an approximate $180 million quarter at aerospace. That's where it shakes out. But certainly New Zealand deliveries will impact that. Our fourth quarter typically in aerospace tends to be our heavier quarter heavier as we try to get shipments out prior to the end of the year and depending on customer acceptance of those.

I think for next year, I think 1.80 is probably a bit on the high side, Matt, to be frank. I think as Neal referenced, we would expect somewhere in the range of growth that we had provided at investor day. We don't see anything at this point that would deviate us from that.

Okay. So the 3% to 6% growth rate is still what we should stick with for next year, then?

Yes. I think being in that range is perfectly appropriate.

Okay, that helps. Appreciate it, guys.

Edward Marshall.

I just wanted to follow up on Matt's question about the cadence in the quarter here. And what gives you confidence that you'll see sales accelerate? I guess the sales growth rate accelerate in distribution in the fourth quarter. Because I think the guidance implies anywhere between, I don't know, 15% to 18% top-line growth in that business. Is it the growth rate that you saw in October that gives you the confidence that that those trends will continue?

Really, I think that -- Ed, I think that we should see about a 5% organic growth rate, which would come to somewhat close to your 18%, but that would be in dollars. $18 million. So I think we're looking at about a 5% organic growth rate. We would kind of break that down into two subcomponents. One would be that we would expect us to have an underlying 3% to maybe 3.5% organic growth, and we expect to add 1.5 to 2 points from clearing backlog that we built during the third quarter in part due to some of the ERP issues that we encountered. So about 5% organic overall.

Yes, and the remainder of that delta -- Ed, you're correct, it's about an 18% or so increase, so a lot of that is being driven by BW Rogers in the fourth quarter.

Okay. So when I look at switching over to the ERP side, when I look at the phases of ERP, we are in phase one. How many phases did you anticipate? And I guess secondarily, did you see any time -- when you talk about inefficiencies around ERP, was it on-time performance that slipped in the quarter? And if so, what percentage of sales would that have been? What excess costs you had to stay on time -- on-time delivery.

Ed, we -- I'll start by saying that we will have multiple different rollouts. We likely will have some 4 to 5 as we convert the 10 to 12 ERP systems to our new M4 system. I think that as we went through this, we learned quite a bit, as did M4. They supported us very strongly at all levels as we went through this. We had a significant amount of inefficiencies, more than either M4 or we had anticipated.

We projected impacted us at the top line between arguably $4 million to $5 million in revenues for the quarter in the area of $1.5 million to $2 million on the bottom line, between forgone profit on shipments and also additional resources that we had to put into the go-live effort. But we've already gone through an upgrade of the system in the last several weeks. We feel good about the improved performance that we're getting, and we know it's actually crucial to our being able to hit our long-term margin goals in the business.

So a little bit of a hiccup here. Actually, this is the third time that I have gone through an ERP switchover. And granted, this is the first phase. We would have liked it to have got a little bit better, but, quite honestly, when we think about a $300 million plus business to have 5% overall -- or excuse me, $5 million overall impact, we need to do better, and we will focus on lessons learned. But it impacted our quarter, but it was not as bad as I've experienced in the past.

Sure. And just to be clear, I mean, the first is always the hardest rollout, right? But not (multiple speakers) this isn't the largest phase that you think you'll tackle as we kind of move forward?

Yes, Ed, a couple of things. You're absolutely right. When you move out of a, call it, a test environment to live production, there's always going to be items that had not been necessarily recognized. Things come up. And I think just to echo Neal's comment, N$, our ERP provider, has done a tremendous job at supporting us, and we couldn't be more pleased.

So as it relates to the size -- we've rolled it out at Minarik, which as we have talked about in the past is about a 10% or so of the business. And as we roll it out across the remainder of our legacy distribution businesses and roll out those disparate systems, we would expect the phases to be not too dissimilar in size. Part of the reason we chose Minarik as well is because it does have slightly lower transaction volumes relative to the core key IT business, and we felt this was the absolutely right place to really roll out the system initially to work out the bugs.

Okay. And then just a final question. You pointed out the sales force expansion cost is a portion of the revision in guidance. I don't know if it changed from maybe last quarter or so. I did see that we have talked about this in the prior quarters. Was it bigger than you anticipated, or was there additional salesmen hired in the third quarter as to maybe why the costs were pointed out as far as the guidance revision?

Ed, I don't think our expectations have changed materially as it relates to the dilutive impact we're experiencing. There really hasn't been a change. I think we are providing just a bit more clarity as to what the impact is.

I see. Okay, great. Thanks, guys. I really appreciate it.

Eli Lustgarten.

Can I just get two clarifications? One, Rob said the tax rate will be 34% for the year. Is that going to be the new run rate for next year, or is that just a one-time situation bringing it down? And, too, you keep referencing Mexico being soft. Can you tell us what's going on in Mexico? Because we see very mixed results, and we've seen actually better performance from some of the other people in the business.

Okay, let me first address the tax, Eli. I would go ahead and presume that 35%, which is a statutory rate, is really our go-forward rate. We've had a number of discrete items this year impacting the tax rate. So it's difficult to say whether we'll have the same level of repeats as it relates to discrete items going forward.

And Eli, if I can handle the question. We have had -- we have struggled with performance in Mexico, driven initially by some mining contracts that we took on really a much larger basis than we had taken before, and we struggled through those. We've also encountered a downturn in Mexico, which I think other companies operating there have seen as well.

We've taken some steps with a new country manager in place, and we are rebuilding both the operations side and the sales side of that business to structure it for improved performance as we go forward. But it has impacted our near-term performance both from market conditions and also some steps that we've taken to change out and rebuild that organization so that it's solid for us going forward.

All right. Can we talk a little bit about what you're seeing both in distribution, especially in the fluid power business as you look out into the fourth quarter and beyond? The fluid power business is softening quite a bit because the ag market is falling apart. And mining is something we know is going to stay where you can continue.

It's very predictable at this point, given what's going on in the mining expenditures and what's going on in coal. Can you give us some sense of what you're seeing in the fourth quarter particularly in fluid power? Because the reports that we got out of both Parker and Eaton have some issues in the fourth quarter as you look out.

Eli, really good point. What I believe that both Eaton and Parker were particularly referring to in the ag markets, etcetera, is the business that they do directly.

Yes, the OEM is down 19%. We know that.

Yes, so we don't have a big ag component of our fluid power business. We are really more focused on the industrial market, and also with -- increasingly with our OEMs as we cross sell those products through our Zeller and Minarik and ACE platform businesses. So actually we see fairly solid growth going forward through the fourth quarter. As we said, we saw 6% growth in the base business in the third quarter. We probably would not be all that dissimilar. Some of it might vary based on shutdowns for our end customers.

But I think that we see a pretty good fourth quarter. Overall for the year, maybe not quite as strong as we would've expected. But on a third quarter to fourth quarter, I don't think we would detect a big change because we don't have that kind of correlation to some of the big OEM businesses that the suppliers like Parker and Eaton do.

And just for me one more. A lot of the distributors have been talking about a slowdown or timing of incentive payments and support payments and rebate payments or so. What are you seeing, and what you have factored in as you look out in the fourth quarter and into next year?

A couple of things there, Eli. You are right: a number of folks have addressed the reduction in rebate income as a contributor; perhaps some of the margin challenges they are facing. We certainly have good relations with our key vendors, and we are very much focused on increasing costs through those vendors that provide us the most support. And we have a number of initiatives to make sure that our rebate income remains level with historical standards.

So you're not seeing much impact at this point from anyone, and you expect it to stay normal is how I should read it?

Yes, that's how you should read it.

Thank you very much.

Scott Graham.

Neal, you made a comment earlier in answering a question; I guess I was a little bit confused on the answer. You said that you had -- obviously we had 2% organic and distribution, but that the growth was plus 7% and then it dropped down to minus 2% at the end of September. Could you -- was the call [semit] 7% in September? Is that what you meant, or was that quarter to date through early September?

Yes, thanks for the question, Scott, so we can get a clarification. Through the first almost three quarters of September, we were up plus 7% growth year on year organically. And then in the last two weeks, we went to a minus 2.5% to minus 3%. So that's that is how we ended up where we felt confident halfway through -- 2/3 of the way through the month of September that we would have a 3% organic growth for the quarter. That's where we really experienced a downturn that took us from a 3% expectation to a 1.7% reality.

Got it. I understand now. Thank you.

Yes, thank you for asking the question.

Neal, when we look at distribution margin, there's obviously very little wiggle room in there for something to go wrong at the levels that it is out -- that it is at right now.

I was wondering with these acquisitions now in the fold getting more comfortable with the Rogers acquisition, is there anything you guys are now looking at structurally where we could maybe take some more costs out to get that margin back into that old 7% to 8% goal line that we were looking for a little bit faster? Because it seems that it doesn't take much disruption to kind of keep you at the 5%.

So I'm just wondering if you have -- with these operations now running, if you see anything that you could structurally do to lift that margin up so that we have a little bit more wiggle room each quarter.

Yes, good question, Scott. I'll break it down maybe into three areas and certainly leave it for Rob to add in. Obviously, for us to achieve our longer-term profit goals for that business, we need to have a higher organic growth rate than we've experienced over the last three to four years. That is one of the reasons where a structural change has been additional sales resources. And while that setting some costs in the near term, we feel that that's really important to driving the top-line growth that we need to get the operating leverage and contribute to those higher margins.

The second -- a little bit smaller impact is that we need to make the improvements that we are planning in Mexico because it is a drag today, and we need to reverse that to it being a positive.

However, the largest single structural change that we are going through, Scott, is the implementation of our ERP system. That is what is going to enable us to reduce our costs by reducing from some 12 different ERP systems to one. It will enable us to integrate the back offices of the acquisitions that we've done over the past four years where we have not taken that step yet because we didn't want to switch them twice.

So when you combine those back-office efficiencies with improved purchasing elements that we know will be available to us, that's really the most fundamental.

What you also saw in the third quarter, the charge that we took was the consolidation of the marketing group from an acquired company into our main headquarters marketing group here in Bloomfield. And those kinds of things we have been able to do in marketing areas, but none of the back-office accounting, AR, AP and purchasing areas. So that's by far the largest structural change we're implementing to our business today that will help drive improved performance.

That's great. Just one last question if I may. Were -- if you said this, I'm sorry. I don't think you did, though -- the JPF units shipped in the quarter and year to date?

Sure. I've got that one, thanks. Scott, year to date we have delivered about 17,500 Fuzes, the majority of which have been USG or FMS sales. We have had significantly lower direct commercial sales of a Joint Programmable Fuze year to date. In the quarter, we delivered 6,400 Fuzes, of which 98% of those were USG.

Last year, through the third quarter we delivered 14,000 Fuzes, about 3,500 fewer Fuzes than this year. The mix was considerably different. Year to date, it was about half-and-half DCS and USG and FMS. And for the quarter -- the quarter last year, it was about 75% of our commercial sales. So certainly quite a difference in the product mix.

Right. And is that leading your confidence, Rob, in that fourth quarter mix should be improved? And by extension, does that mean 2015 gets started off well mix-wise -- 2015?

A couple of things. I'll address the full year. We expect to deliver between 23,000 and 25,000 Fuzes for the year. I wouldn't expect, Scott, that it would be a material change in the mix between USG and direct commercial sales. We're not expecting a major change in that make-up.

And it's very difficult to say what it would look like in 2015. We're always -- these commercial orders are long lead items. It's very difficult to tell where those negotiations -- we typically have these sales every year. It's volatile year to year what those levels will be just based upon commercial -- I'm sorry, customer needs.

Got it. I thought I saw where you said somewhere mix was positive in the fourth quarter. Perhaps I misread that. I understand now, Rob. Thank you.

(Operator Instructions) Jeff Hammond.

Just a quick follow-up on this September issue. It seems like it was isolated to Minarik and Zeller and maybe a little bit of ERP. But can you explain what exactly is happening there and what caused the weakness?

Jeff, I think that what we tried to convey was that, for the quarter, a lot of the weakness was encountered in our Minarik and Zeller businesses. But that was not the sole contributor to the decline in the last two weeks of September. We've looked at that really hard, Jeff, over the last two to three weeks. And we know the regions. We know our Intermountain region was down. We know that we had some specifics there related to mining. We know that South was down, and we know that the Northeast was down a little bit as well.

But in those other two regions, that any one market either product or industry market that jumps off the page at us.

And similarly, we did have a very, very strong close to the third quarter in 2013. And that may have been -- and a lot of that was driven by very strong performance from Zeller and Minarik last year. So maybe we just lost a little bit from year to year in those businesses. But that's the best analysis we have really been able develop at this point.

And Jeff, I was just going to add a little more color for you as it related to Minarik and Zeller. Certainly at Minarik, the ERP had its impact as we've discussed. At Zeller, really some programs that we had expected have gotten pushed out. There has been an increase in backlog in that business, so we feel confident that those will all get converted to sales, just not in the time that we had expected.

Okay. And the plus 5% in October, was that kind of a continuation of fluid power and power transmission doing well, and Minarik and Zeller being weak?

Certainly, our legacy business delivered good results during October. But what I would tell you is that Minarik certainly had a very decent October. So we are starting to see them stabilize out of the ERP implementation. So there wasn't anything specific. Zeller, once again, some program push-outs. So relative growth rates relative to last year were somewhat impacted by that.

Okay. And then how should we start to think about corporate expense into 2015? You had kind of a little bit of jump. And maybe within that just mention pension both expense and cash contribution.

Jeff, certainly, as we've talked on prior calls regarding some of the impacts for the full year, those being the building maintenance we've had campus-wide improvements here that all roll into corporate. Even though in that 100% all necessarily directly house some corporate folks, but that's how the expense rolls up. We've had incentive comp pension and acquisition costs this year that has driven our costs higher than the prior year.

Looking to 2015, once again, we'll provide our full-year outlook in February, Jeff. But certainly we would expect there to be, call it, low to mid single-digit growth there. I mean, certainly nothing in the range that we saw this year.

Okay. Thanks guys.

Arnie Ursaner.

Two questions sort of going on the same thing. Have you thought about whether customers may have pre-ordered over concern about availability with the ERP system, and maybe once they got comfortable that's perhaps the reason why October has seen a pickup?

You know, Arnie, that's certainly a plausible explanation for some of it. And in fact, we did see that earlier in the year as we talked about transitioning our German bearing operations into a new facility. We did have a number of customers that pre-ordered so that they could assure themselves supply as we transitioned in that case to a new facility. But I would certainly expect that some of it may have been caused by exactly that phenomena.

Okay. And then one of your shareholders and I were chatting last night, so I'll ask the question on his behalf. I would never ask this. (laughter) But when you have the ERP system, and we have a history that goes a long way back with you guys with the Australian contract, how should we have some confidence that the quarterly problems you had this go-round in ERP won't linger for an extended period of time? Maybe you could speak a little more about your plan to avoid that.

Well, on the -- Arnie, can I ask a clarifying part? You mentioned the Australian helicopter program (multiple speakers)?

I'm just going back to it was a one-time item that lasted about seven years.

Oh, right. Okay, I got you (laughter). I understand that one. Arnie, we know every ERP transition is difficult. We felt that in combination within for, we had a very strong project planned for this. And we still had clearly some things that when we shifted from that test environment to a production environment, that we learned. Part of it was in the responsiveness of the system, which we've been working on, and part of it as well was in the interaction of various software systems that you can imagine. We have a warehouse management system that has to integrate with this. We have a taxware system that has to integrate with this. We have customer CRM systems.

So we encountered a number of issues in the interoperability of systems that now we believe we have primarily behind us. We understand that we need to do a better job in understanding what the impacts will be on future go-lives as we shift to this new system.

I think we have learned quite a bit through this initial phase, and I think our plan was sound in going live with a relatively small portion of our business. We will continue to take that approach of going forward in smaller, manageable chunks. And it is one where we just have to assure that we can implement that plan in a sound basis going forward.

There will be always be differences unfortunately in each different part of the business that we bring on. I think that maybe anticipating those inefficiencies and being able to discuss those earlier as we enter the quarter or as we are two or three quarters ahead of that, more effectively will be an important part of that process as well.

Okay. And a very short-term question, the Q3 impact of adding extra people. You obviously are seeing a good volume pickup. But are you also continuing to incur higher kind of one-time or emergency expenses to manage the growth?

Well, I think that we incurred some emergency expenses in the third quarter, Arnie, associated with additional resources that we put on our ERP go-live. I don't think that we are seeing any additional one-time charges associated with the sales force expansion. Except for we got through in the third quarter I think the last portion of recruiting expenses for that team, but I think we should largely have the one-time expenses for the sales force expansion behind us now.

I was thinking more on the ERP where you had to add people for deliveries.

Yes, you're exactly right. We did add people in that area to provide additional customer support resources.

And did that continue in Q4, and is that embedded in your current margin view?

Yes, Arnie, we have included some of that, and it is embedded in our current outlook.

Okay. Thank you very much.

Thank you. Ladies and gentlemen, we have no further questions at this time. So I'd now like to turn the call over to Eric Remington for closing remarks.

Thank you all for joining us today. We look forward to speaking to you again when we report fourth-quarter and full-year results in February. Have a good day.

Thank you, ladies and gentlemen, for your participation in today's conference. This concludes the presentation. You may now disconnect, and good day.