Kaman Corp (KAMN) 2016 Q1 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Kaman Corporation Q1 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, today's conference is being recorded.

I would now like to introduce your host for today's conference call, Mr. Eric Remington. You may begin.

Good morning. Welcome to the Kaman Corporation first-quarter 2016 earnings call. Conducting the call today are Neal Keating, Chairman, President and Chief Executive Officer, and Rob Starr, Executive 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 2015 annual report on Form 10-K and the current report on Form 8-K filed yesterday evening together with our earnings release.

In addition, we expect to discuss certain financial measures and information that are non-GAAP measures as defined in applicable SEC rules and regulations. Reconciliations to the Company's GAAP measures are included in the earnings release filed with yesterday's 8-K.

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

Thank you Eric. Good morning and thank you for joining us on today's call. Our first-quarter results reflect our continued focus on execution across the Company and positions us to maintain our full-year outlook.

At a consolidated level, sales increased approximately 2% to $451 million compared to the prior year with strong sales growth at aerospace, offset by sales declines at distribution. We delivered adjusted diluted earnings per share of $0.41, largely in line with expectations for the quarter.

Taking a closer look at the results of distribution, sales for the quarter, as anticipated, were lower versus the prior year, declining 6.8% on a same-day sales basis. This decline reflects continued difficult market conditions in a number of the end markets we serve.

Operating margins declined 60 basis points versus prior year, a good relative result given the extent of the organic sales decline. Our operating profit dropout rate was approximately 11%, far better than our historic performance in similar market conditions.

Our ability to mitigate the negative margin pressure was largely driven by two management initiatives. First, we are realizing the benefit from the workforce reduction and facility rationalization measures undertaken in the fourth quarter of 2015. Second, our efforts to drive improved productivity and profitability as discussed on the fourth-quarter call are beginning to yield results. In spite of the difficult market conditions during the quarter, these initiatives helped us to deliver sequential margin improvement of 60 basis points on relatively flat organic sales levels.

In reviewing end market performance over the past number of years, our three-platform strategy has shifted us to a higher percentage of OEM sales. This shift exposes us to the increased cyclicality of the OEM markets, which, in the current business cycle, has negatively impacted our topline sales growth.

For the quarter, OEM sales on a daily-sales basis declined approximately 12% compared to a low single-digit decline in our MRO business. Industry performance for the period was mixed with seven of our top 10 industry markets experiencing sales declines. Continued weakness in our oil, gas, mining and metals markets accounted for about 260 basis points of our sales decline in the quarter. While these markets now represent less than 5% of our sales, their collective decline of 38% year-over-year had a meaningful impact on our topline sales. These declines were partially offset by improvement in our food and beverage and nonmetallic minerals markets.

In our aerospace segment, sales were up nearly 24% compared to the prior year to $162.5 million driven by record sales for our JPF and legacy missile fuses and the contribution of approximately $17 million in revenue from the recent acquisitions of Extex and GRW, partially offset by lower sales from our New Zealand helicopter program, which substantially was completed in 2015.

Segment level organic sales increased approximately 11% during the period versus the prior year. While segment level revenue was encouraging by almost any metric, operating margin dollars were flat on a lower margin percentage during the period, reflecting several factors. These factors included difficult margin comparison for our legacy bearing product line sales, acquisition related costs, retroactive adjustments from our structures programs, higher intangible amortization, and the recognition of previously capitalized G&A expenses due to deliveries associated with certain military programs.

I'm pleased to report that both our acquisitions favorably contributed to first-quarter results, and the integration and profitability of these acquisitions are in line with our expectations. During the quarter, we incurred one-time acquisition and inventory step up costs, which we expect to moderate as the year progresses.

Despite the difficult comparison to the first quarter of last year, our organic bearing product line continues to perform well. It is important to keep in mind that, due to our industry best leadtimes, our sales patterns are determined by customer requirements which will typically result in increased demand in the second half of the year.

Turning to fusing products, revenues accelerated in the first quarter as we shipped almost 6,800 JPFs, which was up 16% compared to the prior year, and a substantial increase in delivery of our legacy missile fuses as well. We expect fusing performance to remain strong for the balance of the year as a result of the more than $200 million in JPF orders received in 2015, and a combined backlog for our fusing products of over $300 million at the end of the quarter.

The strength of our diversity and the execution across our businesses provided offsets to some of the challenges which impacted our results for the quarter. This enabled us to deliver results in line with our expectations and positions us to accelerate our performance as the year progresses.

Now I'd like to turn it over to Rob to provide you with some additional detail. Rob?

Thank you, Neal, and good morning everyone. I'd like to begin this morning by providing financial detail and adding some additional context to our results.

Overall, while our earnings were lower than last year, they were in line with our expectations. GAAP earnings per share was $0.35 compared to $0.46 the prior year. And on an adjusted basis, diluted earnings per share were $0.41 compared to $0.47 in 2015. The primary difference between our GAAP and our adjusted earnings per share were cost related to the acquisitions of Extex and GRW.

Earlier, Neal provided an overview of the results for the segments, and we thought it would be helpful to provide some additional color on the aerospace operating profit performance for the quarter. On a GAAP basis, operating margin declined 350 basis points to 13.1%. This decrease was driven in part by the recognition of previously capitalized SG&A expense of $[3.1] million, which was relieved from inventory based on deliveries occurring under certain US government contracts, EAC retro adjustments of $1 million, and acquisition and integration costs of $2 million.

Moving to the consolidated results for the period, gross profit margin for the quarter was 29.8%, representing a 90 basis point improvement over the prior year. This improvement was driven by the improved gross margin performance at distribution and the mix of DCS and USG JPF sales.

Taking a closer look at SG&A expenses, we experienced a 10% increase in consolidated SG&A, primarily the result of increased SG&A at aerospace split evenly between acquisition and organic growth. The increase in organic SG&A expense at aerospace was driven by the recognition of previously capitalized SG&A, as discussed earlier, partially attributable to lower than anticipated deliveries of legacy fuses in 2015, which we now expect to occur in 2016. The process of capitalizing SG&A expense on certain government contracts is a normal part of our business, and as noted, the capitalization of these expenses or relief of previously capitalized amounts is dependent on the timing of deliveries to the US government.

At distribution, SG&A expenses flattened compared to the prior year, reflecting that benefit from our workforce reduction and facility rationalization which we have partially redeployed toward the development and implementation of our productivity and profitability initiatives Neal mentioned earlier.

Our free cash flow in the quarter was a use of $1.9 million. First-quarter cash flows are typically the lowest of the year, due in part to working capital requirements and our annual pension contribution and incentive payouts.

Our balance sheet position remains strong as we ended the quarter with a debt to capitalization ratio at 44.6% and a debt to EBITDA ratio of 2.9 times, both within our long-term target ranges.

I would now like to turn to an update of our 2016 outlook. Based upon our performance in the first quarter and our expectations for the balance of the year, we are reaffirming our full-year outlook.

In review, at aerospace, we are expecting a significant year of topline growth between 17% and 20%, which corresponds to a sales range of $700 million to $720 million. Aerospace's full-year growth rate is lower than the rate we experienced in Q1 due to the strong sales comp that we will be up against in Q4 of last year and the fact that our acquisitions will lapse to organic growth during the fourth quarter.

We expect full-year aerospace operating margins to be in the range of 18.3% to 18.6% and in an adjusted EBITDA range of 21.8% to 22%. The margin forecast is unchanged from our prior outlook and excludes one-time acquisition related costs of approximately $5.5 million related to inventory step ups and integration expenses.

The full-year sales outlook at distribution remains $1.125 billion to $1.165 billion, which translates into an organic sales decline of between 1% and 5%. This compares to the 6.8% organic sales decline we experienced in Q1. Our expectation is that our comparative organic sales growth rates will trend -- will tend to improve, most notably in the second half, as the comps get a bit easier.

Operating margin expectations at distribution remain at a range of 4.4% to 4.6% as we benefit from the restructuring and productivity initiatives we have taken. Distribution EBITDA margins are expected to be in the range of 5.8% to 6%. The expectations for our quarterly earnings cadence remains back-half weighted with slightly more than 60% of our full-year earnings coming in the second half.

We remain on track to achieve our free cash flow outlook for the year of a range of $50 million to $60 million, which is within our long-range target for free cash flow conversion of 80% to 100% of net income, and our outlook for 2016 would produce a three-year average free cash flow conversion rate in excess of 100%.

With that, I will turn it back over to Neal for his closing comments.

Thanks Rob. while we are not satisfied with our headline results in the first quarter, we are encouraged by the underlying trends in both of our segments. In aerospace, we are progressing with the integration of both Extex and GRW, have broken ground on our bearing addition here in Bloomfield, and increase our backlog to over $700 million. In distribution, our daily sales rates stabilized and we were able to improve margins by 60 basis points. As we progress through the year, we expect to see further improvements across our businesses and we remain on track to achieve our outlook for the year.

With that, I'll turn it back over to Eric for questions. Eric?

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

(Operator Instructions). Edward Marshall, Sidoti & Company.

Good morning guys. So, I wanted to ask I guess the 18.3% to 18.6% on aerospace, and looking at the year-over-year comparisons, especially in the first quarter, that suggests a pretty healthy recovery on the margin throughout the balance of the year. I'm assuming that that's related to fusing and maybe even some bearings like it has historically, but maybe if you could walk us through some of the expectations on the aerospace side that anticipate to get that margin to where it needs to be to hit your guidance for the year.

This is Rob. Good question. As we look towards the remaining three quarters of the year, we do expect to see -- there are couple of key drivers to meeting those margin expectations, those really largely being on account of the ramp up in bearings, both in sales and margin as we go through the year, because as they increase their production, they typically will get better overhead results. So we certainly expect to see improvement in bearings as we move through the year.

Also on the aero systems side of our business, we do expect to see sequential improvement in those performances in those businesses.

On the fusing side, we certainly had a very strong quarter, as we talked. We had a good shipment of DCS in this quarter, and we remain on track. We are not going to -- we don't expect to see as much seasonality in fusing as we have in other prior years. That we expect to be more level with some potential upside based on the mix of shipments that we ultimately deliver between DCS and USG.

Got it. And the $1 million charge in the quarter, or I guess the impact, not charge, from the dispute of the contract, if I think about some of the programs that they are related to, for every monthly change of, say, one aircraft in particular, is that the kind of expectation I should think -- I'm assuming it's the revenue recognition kind of assumptions?

Actually, I'll start with this, and Rob can fill in any details. These are really estimates at completions of contracts. So, they are not contract disputes, but rather they are changes in either the learning curve that we are experiencing on the program, or what you hit on. As we have changes in volume, it impacts our overhead rates. And those changes in overhead rates will also impact our estimated completion of the contract.

So, we did have lower volume in a couple of our aerostructures facilities, and as we reran our EACs as we do at the end of every quarter, that lower volume was a big impact in overhead rates. And that's what really was a major driver in the $1 million charge that we took for EACs in the quarter.

And just to clarify, is that a charge, or is that just impact of kind of the assumptions on a go-forward basis?

That's just a change in estimates going forward.

So that will be an impact of about $1 million a quarter for the remainder of the year.

No, the way that the EACs work is we take a look at the projected delivery overhead rates, everything that's related to completing the program, and then we, through a retro adjustment based on what we (multiple speakers) basically I would look at it as a true up.

Yes, no problem. And then the distribution, you gave some pretty good color on what's been impacting you there. I was curious if you could kind of walk through how that business trended on a monthly cadence. And the year-over-year comps didn't look as good, so maybe sequential comps there. so I assume that there was some pickup throughout the first quarter.

You're right, Ed. We did pick up through the first quarter. As you know, our first quarter and second quarter of last year in distribution were really quite strong, so our year-to-year comps are pretty tough. But as you pointed out, sequentially they looked quite a bit better.

During the first quarter, we started out a little bit weak, and we kind of firmed up in February and March. Pretty much consistent sales in February and March, and so far, April has come in at about the rate that we had for the first quarter. So, pretty firming and flat, but when we do it on a comparison to a very strong first half of last year, clearly down.

Got it. Thanks very much guys, appreciate it.

(Operator Instructions). Matt Duncan, Stephens.

Good morning guys. Neal, maybe if I could ask that last question a bit more directly. Do you have the percentage year-over-year organic daily sales change, rate of change, for January through April? Just curious what that trend line does look like.

Sure. We are down about 8% in January, down about 3% in February, and down about 8.5%, between 8% and 9%, in March. When we look at our -- as we look at the cadence of our sales, though, last year, Matt, we went from -- we increased in sales about 10% from January through March last year. So the sales rates, the daily sales rates, were relatively consistent between February and March, just at March of last year was -- it was a record month for us.

Yes. And April, Neal, do you have that handy? How does it look on a year-over-year basis?

On a year-over-year basis, we are down about 6% to 7%, and the daily sales rate is, as I said, about the average that we had for the first quarter.

Okay, that's helpful. As you guys --

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Okay. As you guys talk to your customers right now, what are you hearing from customers at KIT? Are they feeling any better or any worse? Is there any sense that things could be bottoming? Are you hearing anybody talk more positively, or is it really just sort of more of the same?

You know, it varies by the end industry group that you are talking with, but I think we are seeing -- the rates of decline in oil and gas in mining is lower simply because it's beginning to be an easier comp when you look at it sequentially. So we don't -- oil and gas we don't see as anybody getting positive on it.

We had a little bit of a weakening of the dollar up until the last couple of days, and so some of our exporting OEMs were feeling that would give them an advantage. We've kind of come down to our stalwarts of food and beverage that are really helping our product mix. But we are really -- as you can tell from what we've said in our prepared remarks and also in answers to questions, both in the fourth quarter and now during this call, we are not counting on an uptick in volume through the balance of the year to get to the low end of our range. We'd like to see a little bit of uptick, especially in the second half the year where the comps are easier, but we are really structuring our business and focusing on being able to deliver acceptable levels of profitability and improvement year-over-year in a flat sales environment.

Okay. And then last thing for me, just with the margin improvement initiative at KIT, if you were to start to see your sales growth return to sort of a mid to high single-digit, a bit more normalized level of sales growth for that business in a normal environment, whatever that is these days, how much operating margin expansion do you think that business would be capable of, given the things that you are doing there?

It would enable us to make a nice step towards the 7% target that we've set.

Okay. And any way to quantify how much, are talking it could be up 100 basis points or is that a little much?

It could be up 100 basis points.

Okay. Very helpful. Thank you.

Pete Skibitski, Drexel Hamilton.

Good morning guys. Just a couple of clarifications. I guess, Rob, on the transaction integration costs in aero, I think it was about $2 million in the quarter, and I think you're still expecting $5.5 million for the full year. Is that just level loaded through the final three quarters, maybe $1.1 million, $1.2 million or so per quarter, or is it more so aggregated into the second quarter or third quarter? And then does it go to zero in 2017?

Yes, good question. Of the $2 million, the majority of that was inventory step up in the first quarter. We did have integration expenses, but the integration expenses we expect to pick up towards the second, third and fourth quarter. It's hard to say exactly the timing, but I would say that the $5.5 million, we do expect it to be first half weighted. There are certainly some costs in the third quarter and some certainly in the fourth quarter, but it should be at a lower level by the time we get to the fourth quarter.

In terms of moving to 2017, it is possible that some of those expenses could move over to 2017, but certainly that's not the current thinking.

Okay. Got it. And then just one follow-up I guess. On the $3.1 million SG&A in aerospace that came out of inventory, it sounds -- is it true? Were you guys expecting this? Because I know you didn't change your guidance. So were you expecting it? And maybe just a little more color on why related to fuses in particular, and how often -- I couldn't remember another time where somebody (multiple speakers) so just whatever you color you can give would be great.

Yes, it's a good question. That release of G&A was in large part due to the delivery on certain of our missile -- legacy missile programs. And if you recall, we anticipated those deliveries a while back to have occurred in 2015 but due to customer requirements and other challenges for programs, we are really beginning to deliver that. So you are seeing a larger than normal release of capitalized G&A just based on the timing of those shipments and the fact that that has built up over an extended period of time.

Okay. You carried inventory longer, so the SG&A builds up. The longer you have it, the more the SG&A builds up basically.

That's correct. It's a bit of unusual for us. We typically don't have those types of extended delays. It's just something we wanted to highlight just as particular as a point of comparison to the first quarter last year.

Okay, makes sense. Thanks very much guys.

Ryan Cieslak, KeyBanc Capital.

Good morning guys. I guess the first question I had is on the distribution side and cost actions that you guys had taken in the fourth quarter. How do we think about the benefits from those cost actions? Are they now fully realized in the numbers at this point, or do you expect some incremental benefits to bleed through here into the second quarter?

Yes, those costs we are largely realizing the benefits of the actions we took in 2015, and those actions, the benefit of those are reflected in our outlook. So we would expect to see that continued benefit. We talked I think it was around a $7 million or so annualized benefit relating to those actions.

Okay. Got you. Is there a way, Rob, to think about the cadence or the trajectory of the margin distribution going into the second quarter? I think there was some beginnings of improvements sequentially from the fourth. Can we think about it at the same magnitude into the second, or is there something that's different about the second quarter that would change that in either direction?

A couple of things there. We had touched on the fourth-quarter call that we have some kind of timing issues around some of our employee related costs. So relative to the first quarter, that should be about a 60 basis point relief relating to those expenses. Certainly, we would anticipate to see that come through.

In terms of the overall balance for the rest of the year, in order to achieve our outlook, we've got to deliver margins between $4.6 million and $4.9 million for the balance of the year. And we feel pretty confident in being able to do that.

Okay, got you. And I just would be curious to know, Neal, any sort of updates on the K-MAX program and what you're seeing there, that would be helpful.

As we've reported, we've got firm contracts on five aircraft. Today we have deposits on three additional aircraft. We are hoping to turn those deposits to firm contracts here in the next few months. When you think about, from a production perspective, we are on track at our various facilities to be able to support the delivery of the first aircraft in early 2017. And last month actually, we had HAI, which was the big helicopter show, and it was really a very active show for us across, quite frankly, everything from our new Extex business, but also a lot of interest across a very broad customer group on the opportunities that they see now with K-MAX going back into production. So, we need to turn those opportunities into contracts, but we are pleased with the progress so far.

Okay. Thanks guys. Good luck.

(Operator Instructions). Shannon Burke, Gabelli & Company.

Good morning. So, just going back to distribution, if you could just give any more color on product line breakdown in the quarter. How is fluid handling performing versus bearing in power transmission, automation control?

Sure. This is Rob. For the quarter, our fluid power business was down in the high single digits year-over-year. Our bearing in power transmission was down more or less in line with segment average, and our automation control in energy was down low to mid single digits over the year. So pretty much in line with what we've seen with our competitors, in fluid power in particular with some of the OEMs with oil and gas pressures probably faring a little bit worse than our other product lines.

And do you expect these trends to continue throughout the year?

I think really we certainly expect the year-over-year comparisons across all three of these to improve as we move through the year, just given the relatively easier comps, in particular in the second half. The second quarter is a very difficult comp. Our daily sales rate in the second quarter last year was actually a record for us. So certainly the oil and gas markets will play a fairly large role as we look at fluid power in particular, and what the impact maybe, but we certainly expect to see relative improvement.

Okay. And then just switching to aerospace, GRW, how is the integration progressing and have you identified any synergies that you weren't expecting that you could quantify? Anything there?

Sure, Shannon. The integration activities are going actually quite well, so they are actually going according to plan, because we've planned for them to go well. But I'll tell you what's interesting to us is, from a sales synergy perspective, I think we are seeing more opportunities. We counted on opportunities in leveraging our specialty bearings sales organization across the globe. I think that what we are realizing is that we may have more opportunities sooner in the US than we otherwise anticipated. So, very strong business, great products, great reputation in the marketplace, and now we are hoping to provide them some additional exposure and focus in the aerospace industry, because that's really been our sweet spot.

Okay. And could you quantify that at all, or is it too soon to -- ?

You know, I think it's too soon. I think probably as we get in later in the year, we will be able to give a little bit of a retrospective on that. But we feel really good about both GRW and our Extex acquisitions, as I commented earlier. Even at HAI, the opportunities for our Extex business were really coming through.

Okay, great. Thank you so much.

Chris Dankert, Longbow Research.

Good morning guys. Thanks for taking my question. Just I want a quick follow-up. In the past, you had mentioned that you were expanding JPF production capability and I think specialty bearing as well. Can you give us an update there? I assume we've got all the shifts filled now, you probably have the working capital. Is it that kind of on track?

We are on track for -- let's start with our JPF ramp up. Gerry Ricketts and the team there are on track for that ramp up. We made very good progress in the late fourth quarter and now through the first quarter of this year, and we feel comfortable being able to get to the 30,000 to 34,000 unit outlook that we've provided. We continue to add some staff. We are adding it at a measured pace so that we can assure we have them trained fully before they begin to participate on the production lines. So we feel good about that. And actually we just broke ground within the last three weeks on the expansion here for our specialty bearings business, so that was right according to the schedule as well.

Fantastic, fantastic. And then I guess as far as our checks go, we've been hearing quite a bit of cannibalization in the oilfield but elsewhere as well, guys taking parts off idled machines, that kind of thing. Has that been a major impact for your business or not so much?

It's a good question, Chris, because that's so hard to quantify. So I guess I would be -- without trying to duck the question, I don't know that it would impact us any more than it would impact any of our competitors. But clearly, they are doing everything to minimize any expenditures whatsoever. So it's very common for them to cannibalize existing equipment.

I guess that's kind of continuing apace right now, from what you've heard at least?

I would say so. When we talked about our year-to-year decline in oil/gas, and we put mining in that because it's commodity related, and for us metals as well, because a lot of our exposures in metal has been in specialty metals that are focused on oil and gas end markets. We were down 38% year-to-year. We were down about 10% to 11% sequentially. So we are seeing that start to run its course. And that's why we anticipate that even given no uptick in those markets that we would have favorable comps in the second half of the year. But again, as everybody looks at their modeling and assessments, for our distribution business, second quarter of last year was an all-time record from revenues. So that's going to be a very difficult compare for us.

All right, that's helpful. Thanks guys.

I'm not showing any further questions at this time. I'd like to turn the call back over to Mr. Eric Remington.

All right. Thank you for joining us for today's call. We look forward to speaking with you again when we report second-quarter results in July. Thank you.

Ladies and gentlemen, that does conclude today's presentation. You may now disconnect and have a wonderful day.