Kaman Corp (KAMN) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter 2016 Kaman Corporation 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 be given at that time. (Operator Instructions). As a reminder, this conference call may be recorded.

I would now like to turn the conference over to Mr. Eric Remington, Vice President, Investor Relations. You may begin.

Good morning. Welcome to the Kaman Corporation third quarter 2016 earnings call. Conducting the call today are Neal Keating, Chairman, President, 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 includes 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 financial measures as defined in applicable SEC rules and regulations. Reconciliations to the most comparable GAAP measures are included in the earnings release filed with yesterday's 8-K, a copy of which can be found in the Investor Relations section of our website, which is 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 on today's call. Yesterday, we reported third quarter performance that was in line with our profit expectations as we executed well in our Aerospace segment and navigated through continued difficult end market conditions in our Distribution business. At a consolidated level, sales were $453.5 million, an increase of 4.5% over the prior year. This reflects a 30% increase in Aerospace segment sales which includes strong organic growth of 17% and an $18 million contribution from recent acquisition.

Earnings in the quarter were $17.5 million or $0.62 per diluted share which is essentially flat with prior year results. While net earnings were flat, adjusted EBITDA increased 8.4% to $42.3 million when compared to the prior year.

Moving to our segment performance, Distribution sales were $274.4 million compared to $296.3 million in 2015 which reflects one less business day and a 6.3% decline in organic sales per sales day. Sales came in below our expectations with mixed results across our customer base, end market and product platforms. When we delivered our updated outlook last quarter, we were expecting slightly positive sequential sales growth in the third quarter and instead, we ended up with slightly negative sequential sales growth due to continued weakness year-over-year in mining, paper, chemical manufacturing and transportation equipment.

On a year-over-year basis, 25% of our third quarter sales decline was attributed to oil, gas, and mining end markets which now account for less than 5% of segment sales. Both OEM and MRO sales were down about the same percentage year-over-year with fluid power platform stronger than bearing and power transmission and automation. While September was our strongest month of 2016 to date, in fact, the strongest month from September 2015 we could not offset the weakness experienced in both July and August. Segment level operating profit was $11.9 million, 4.3% of sales or $12.2 million and 4.5% of sales when adjusted to eliminate restructuring and severance costs. This compares to $14.4 million or 4.9% of sales in the prior year. The margin decline was primarily due to deleveraging associated with a lower sales base and we are encouraged by the fact that our dropout rate was less than 12%, significantly better than it would have been absent the impact of our productivity and efficiency initiative.

As discussed in previous quarters, we continue to invest in operational process improvements in data analytics primarily focused on expanding operating margin and these efforts are providing the expected level of benefit. However, the benefit has been largely offset in the near-term by the implementation expenses associated with this initiative. Which were $2.8 million in the third quarter. We expect a majority of these costs to begin to moderate as we enter 2017.

In addition, we continue to manage operating expenses and staffing levels. However, given the lower sales volume and one less sales day these efforts were not enough to offset the impact of de-leveraging, which is mainly lower absorption of our fixed cost and lower vender incentives in the quarter of $1 million year-over-year.

Turning to Aerospace, we delivered strong sales growth of 30.3% or $179 million during the quarter driven by an exceptionally strong quarter in our fuze business and an $18 million contribution from GRW and EXTEX. As Rob will detail later, we expect strong segment level sales to persist through the fourth quarter, primarily driven by fuze backlog, strong bearings performance and acquisitions.

In our bearings product lines sales continued to grow organically in the quarter and we are up sharply versus the prior year as a result of our 2015 acquisition. I'm pleased to report that both acquisitions are performing in line with our expectations and both were accretive to net earnings and cash flow in the quarter. However, they are a drag on segment operating margin given the approximately $2 million in associated depreciation and amortization.

With respect to our fuze business, the volume of shipments increased by 150% year-over-year and in total we shipped approximately 9500 fuzes during the third quarter. We expect shipment levels to remain elevated through the balance of the year and well into 2017 as we deliver against the strong pipeline of orders already in backlog.

During the quarter, we also continued to make progress on our structures program and believe we are moving in the right direction to address the operational issues we encountered earlier in the year. As we look to the balance of 2016 and into 2017, we are encouraged by our ability to execute in a dynamic landscape. In distribution, we are pleased by the positive impact from our productivity initiative and the potential long-term implications for margin levels. That being said, we are operating in an exceptionally choppy environment and as we enter the final quarter of the year we remain focused on the factors we can control and executing our plan.

Now, I would like to turn it over to Rob to provide you with a closer look at our numbers and outlook. Rob?

Thank you, Neal good morning, everyone. I'd like to begin this morning by providing financial details and adding some additional context to our results. GAAP earnings per share were $0.62, the same as the prior year and on an adjusted basis diluted earnings per share were $0.64 flatly higher than 2015 despite a tax rate that was 120 basis points higher. The higher tax rate resulted from international rate differentials and discrete items requiring additional provision in the quarter.

Looking more closely at our consolidated results for the period, gross profit performance remained strong with the margin in the quarter at 29.9%, down 10 basis points from the prior year. For the quarter, gross profit margin percentage improvement seen at distribution was offset by margin declines at aerospace, driven primarily by significantly higher mix of USG, JPF deliveries. If you recall, in the third quarter of 2015 approximately 80% of our JPF Fuze deliveries were direct commercial sales as compared to 3% in the third quarter 2016.

Taking a closer look at SG&A expenses we experienced 4.2% or $4.3 million increase in consolidated SG&A, which includes $5 million in expenses from our 2015 acquisitions. Organic SG&A decreased by 0.8% over the prior year period and consolidated SG&A as a percentage of sales decline 10 basis points. We benefited from lower corporate expense in the quarter as we have favorable experience across a number of line items and continue to focus on tightly managing expenses.

Earlier Neal provided an overview of the results for the segment and we thought it will be helpful to provide some additional color on the performance of Aerospace in the third quarter. On a GAAP basis the operating margin declined 370 basis points to 16.5%. The change in year-to-year operating margin is largely attributable to the previously discussed change at JPF product mix, a 50% increase in intangible and fixed asset amortization, acquisition and integration related costs of $0.5 million and a $3.4 million negative differential and EAC adjustments when compared to last year's third quarter.

I would now like to turn to an update of our 2016 outlook. Based upon our performance of the first nine months, we have updated our expectations for the remaining quarter of the year and we've made corresponding adjustments to our full year outlook. At Aerospace we continue to expect significant topline year-over-year growth, although we have lowered our expectations due to some program shifts into 2017. We now expect sales to be in the range of $700 million to $710 million down slightly from our previous range of $710 million to $725 million.

Our revised expectations correspond to an increase of approximately 20% year-over-year. The reduction in our Aerospace sales outlook is due to a number of program push-outs from 2016 to 2017. Programs experiencing push outs include a significant JPF DCS order. The Peru SH-2 program due to contract modifications and certain missile fuze programs. Also impacting our outlook our weaker than expected helicopter MRO results as flight hours on the commercial K-MAX fleet have been lower than anticipated.

We now expect full year Aerospace operating margin to range from 16.4% to 16.6% or 17.2% to 17.4% when adjusted for one-time acquisition related costs of approximately $5.5 million primarily involving storage step ups and integration expenses. Our reduced profit margin expectations are primarily driven by the push out of a large JPF DCS order we had previously expected would occur in December.

The change in our delivery expectation is due to a delay in receiving the necessary government approvals. While we expect to be able to partially mitigate the shipment and timing of this DCS delivery to higher levels of USG JPF deliveries, the profitability differential between direct commercial sales and U.S. Government sales has caused us to adjust our operating profit expectations for the quarter and for the full year.

In spite of the JPF delay, we are forecasting a strong fourth-quarter for Aerospace with an expected margin of approximately 20% driven largely by our bearing product lines. Looking at distribution, the lower than expected sales levels achieved in the third quarter and market conditions overall have caused us to lower or sales range for the full year to $1.11 billion to $1.12 billion. This compares to our previous range of $1.125 billion to $1.15 billion.

In addition to market conditions approximately $5 million of engineered project work within our AC&E product platform will be pushed out of 2016 into 2017. Given our revised topline expectations we are adjusting our expectations for operating margin for the year to a range of 4.3% to 4.4% from our earlier range of 4.5% to 4.8%.

Our lower corporate expense results in the third quarter will carry through the balance of the year and we are lowering our full year expectation by $3 million to $52 million. Our year-to-date strong cash flow performance gives us confidence to raise the lowering of our outlook for the cash flow from operations for the year, coupled with slightly lower expectations for capital expenditures this allows us to raise our target for free cash flow for the year to a range of $55 million to $65 million from our prior guidance of $50 million to $60 million.

This positioned us to achieve our long-term target for free cash flow conversion 80% to 100% of net income and would result in a three-year average free cash flow conversion well in excess of 100%. With that, I will turn it back over to Neal for his closing comments.

Thanks, Rob. I'd like to close with just a few comments highlighting both our near-term performance and several developments that will help drive longer-term growth across Kaman. The diversity of our products and the markets we serve has been one of our key strengths and this quarter was no exception. While our distribution business dealt with more challenging market conditions than anticipated, Aerospace delivered a solid performance led by Bearings and JPF. We are also encouraged by the early contributions of our new acquisitions, EXTEX and GRW.

Looking at the fourth quarter, facing a push out of DCS JPF shipments the team was able to pivot and maintain production levels to satisfy other customer demand. And as we look to the longer-term, we see progress towards margin expansion and distribution and demand across the portfolio in Aerospace. Overall, we've seen progress so far in 2016 and our position to close out the year on a solid note and enter 2017 on a very strong footing.

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

Thank you Neal. Nicolle may we have the first question please?

(Operator instructions). Our first question Edward Marshall of Sidoti & Company. Your line is now open.

Hey, guys. How are you? Good morning.

Good morning, Ed.

Good morning Ed.

So I'm curious is it possible to quantify the amount of fuzes that were shifted into 2017?

This is Rob. I don't think we want to specify the exact number, but it's in the call it, 2,000 range.

Okay. And maybe (Multiple Speakers).

It was significant.

It was meaningful.

Yes. Right. I mean I guess maybe asked another way then could you talk about maybe the margin dollars associated with it or maybe the EPS impact that would have been -- obviously I realize they are higher margin product than DCS.

Yes.

Order of magnitude.

Yes. No. Understood. As you know, certainly a direct commercial sales our priced significantly higher than our USG just given the nature of the business and the cost to produce the fuzes are pretty much at par relative to each other so let's just say the profit -- the differential in the sales dollars, Ed, drops through pretty much at a hundred percent just given price differential to no cost differential and I think our USG pricing is pretty much in the public. A little bit north of $3,000. I'm really not at liberty to really talk too specifically around our DCS pricing Ed.

You can't fault me for trying, that's for sure.

No, no, absolutely not, no it's not. And you know Ed given meaningful, given the impact that it did have on the fourth quarter because of this shift into 2017, we did anticipate the question, but we do have to recognize the nature of the business and the fact that it is - direct commercial sales are negotiated individually, priced individually, so it it's a significant portion of the impact for the year.

No. Understood. I was just seeing if I could get the information to back into numbers that you haven't provided before. That's all.

Good for you.

So , you know, as we look at kind of -- as we look at kind of the Aerospace cycle and what's going on specifically with wide-body, I was curious about the Bearings business in particular because that's really the place that I think you're most exposed on -- to commercial Aerospace and it has some of the highest margins in the company. So kind of talk about what you're seeing coming through Bearings and potentially how you're preparing for say 2017.

Sure. You know, Ed, we continue to have organic growth in our -- in our Bearings business , in addition to the strong growth from the acquisitions. As we look at it and certainly work with our customers , you know, there is a lot of talk about some downturn in wide-body deliveries that will occur out a few years into the future as they may adjust their rates -- begin to adjust their rates down but ,quite frankly we have some off -- we have some offsetting growth there as well. We have talked about the A-350. Clearly that -- that's -- the delivery rates for the A-350 are accelerating. We've had a very nice tick-up from year-to-year in our business with Airbus on that aircraft and we anticipate and our planning for continued growth next year as well as content that Rob Patterson and his team have been able to get on a number of the new business jets which while smaller in content will help to offset some of the downturn that we may see specifically in the triple7 aircraft but it's something we're keeping our eye on. We think that the impact is a couple years out yet and -- and we have had other programs that we've worked very hard to win that are still in their growth mode.

Got it. And you have been generating more cash as of late. I'm curious I understand acquisitions is always something we talk about, but when you look at the capital deployment I'm curious about historically you haven't been a big acquirer of your own stock. Is that something that -- that is not in the pecking order for capital or is that something that -- if we did see a downturn in the shares here that you would kind of step into the market. I'm just kind of curious about the philosophy.

No. Excellent question. Certainly as we look at capital deployment in terms of rank order priority certainly we want to grow the business. That is our highest priority in terms of capital deployment. So we have seen really a significant portion of our cash dedicated towards acquisition and capital expenditures. Certainly we have never turned down a capital expenditures request, certainly from our Bearings business and elsewhere in the organization, where it makes sense. As it relates to the share repurchase we have certainly put a program in place to offset dilution relating to management grants and employee stock grants and that remains in place. And as we talked about when we put the $100 million authorization out there, certainly if there was a dislocation in the market and we felt there was a disconnect significant disconnect between the value in the stock we would certainly give consideration to take some action.

Great. Thanks, guys for all your info. Appreciate it. Okay.

Thank you, Ed.

Thank you. Our next question comes from the line of Ryan Cieslak with KeyBanc Capital Your line is now open.

Hey. Good morning, guys.

Morning Ryan.

Morning, Ryan.

First of all, I just wanted to maybe get a little bit more color on the distribution sales trends. I mean, Neal, you mentioned that September was the strongest month for you guys. Maybe just specifically, how do we think about the daily sales rate in September relative to what it was for the full quarter and any commentary on what you're seeing, what you saw here in October?

Yes, July and August were two of the three weakest months that we had in the year so far Ryan. In fact, only January was lower. September was a good tick up. As I said, our strongest month of the year and our strongest months in September of 2015 it was, and September of 2015 was actually a very good month as well. So that was kind of the cadence through the quarter. We actually did pretty well at the beginning of July. We were down maybe 2% to 3%, but the tail end of July and all of August turned down and then we saw that tick up in September. Right now, as we look at it we're down between 2% and 3%. So far month to date it is, obviously, we haven't closed.

And if you look at our outlook for the year, the way that we approach it, as we said, we were feeling a little bit more confident as we were entering the third quarter. Hence we had our projections up between 1% and 2% and we ended up down between 1% and 2%. If you look at our rate for the third quarter and you just have that flap through the fourth quarter, that gets us to the low-end of our range and that would be obviously again down from year-to-year. So, we felt confident in putting that out there, but we'd certainly like to see some uptick and get closer to the high end of that range know what that would do for the profit contribution for the business.

And then, Neal, was there anything in particular , certain product line or end market that you would call out where you -- where you saw the greatest weakness relative to your expectations in the third quarter in.

You know, Ed, there's two parts to that. We had anticipated that the oil, gas and mining markets would be flat year-to-year and that was what gave us confidence. We kind of felt we were at the bottom. We were actually continued to be down a couple percent there and that was a contributing factor. When we look at -- at it sequentially, we actually were up a little bit in our fluid power business, which we were glad to see. We were, down low single digits in our -- our traditional bearings and power transmission and our AC&E platform was actually our weakest. It had been stronger earlier in the year and that -- that caught us a little bit by surprise in the third quarter. So I would say the combination of weaker AC&E platform sales and sales into oil, gas, and mining continued to decline were the two things that -- that were different than when we had anticipated last time we were on the call.

Yes, Ryan I would just make one other comment to hopefully give some additional context to what Neal just mentioned. In our AC&E we have a pretty large exposure into the kind of commercial construction and other markets and I think if you had read -- I'm sure you did read Wesco's report their reports came in weaker than expected as well. We saw a down turn in some of those markets that were just not expected as we enter into the call at the end of the second quarter. Certainly contributing.

That's really good color, Rob. Any way to think about non-res construction or construction in general as a percent of your AC&E business or anything specific around that?

It is certainly a -- they have a greater exposure to that than the rest of our distribution business does. Certainly has an impact on them, but there were other reasons for their miss, but that is certainly a contributor. It's not -- to the overall distribution portfolio, Ryan, it's not all that material but it certainly did not help in the third quarter.

Okay.

I would say, Ryan, that probably a bigger impact is the continuing strength of the dollar and how that impacts our exporting OEMs because it is a -- a much more OEM -- excuse me -- OEM and capital expenditures for machinery and equipment correlated business than -- than the balance of our distribution portfolio products.

Okay. And then is there any way to think about what hurricane Matthew might have had or is having with regard to the sales? I guess not just distribution but also any impact to the airplanes business.

You know, we haven't to the aerospace business. We did lose a couple production days, but we anticipate primarily in our -- obviously in our Jacksonville and/or LAN dough facilities but we didn't have any damage to the. You know, we had to allow for our employees to be able to make sure that their homes were secure and families were in good shape prior to come willing back to work, but we would anticipate being able to make that up over the balance of the fourth quarter so we were -- I will say we were lucky there. We prepared for the worst, but actually came through it with -- with no real -- no damage at all. On the distribution side we did a little work as you would expect with Steve and his team on the impacts. You know, we have lost some branch sales days, but it -- we really haven't had a big impact yet. So hopefully we'll benefit some from -- from requirements to replace product that may have been damaged in flooding or other , you know, wind related damage, but not a big impact to us.

Okay. And then the last one I had and I'll jump back into the queue. You know, on the JPF order push-outs and it sounds like it was a government approval issue, Neal, is this just something that you view as one time or is there any -- any indication that this is something different that's going on within the industry from a commercial international standpoint? Just any color there would be helpful.

Yes, Ryan. It's a little different, but I think that it's primarily driven by where we are in the election cycle and what people want to be seen as doing before the -- the election, but we think we'll get through the election and things will return to whatever is considered normal anymore but we view it as a one time event.

Okay. Thanks, guys.

Thanks, Ryan.

Thanks, Ryan.

Thank you. Our next question Matt Duncan of Stevens. Your line is now open.

Hey. Good morning, guys.

Morning, Matt.

Morning, Matt.

So, I want to take another stab on the push out and let's look at instead of just at JPF kind of the total amount of push out if we can Rob, I mean if I look at prior guidance, the assumption that you had in that guidance for the third quarter and where you actually came in you did a little better when you thought you were going to. It looks to me like the total push out is somewhere around call it $20 million out of the fourth quarter into next year. First of all is that a pretty accurate number and secondly, does that just kind of all follow into the first quarter or how do we think about the timing of where that revenue goes?

Yes, no Matt, your math is fairly accurate, though that thoroughly corresponds to what we're seeing, so that's really spot on. In terms of the timing as those programs get pushed into 2017 we expect a good portion of those to be in the first half of 2017. I mean, ultimately it really will depend on when we receive approval for the DCS order, that will certainly be the gating item on that portion of it. The other items that we talked about that haven't been pushed out whether it be Peru or some other structures programs, we do anticipate making some of that up in the first half for sure. How much of that's really going to fall into the first quarter versus the second quarter? Very difficult to say right now. We will be able to give a little bit more color certainly we are on the year-end call and we have more visibility into that Matt.

Okay. And then I would think that that's going to have a net positive effect on the year-to-year margin comparison given that those DCS sales for JPF are pretty high margin sales, right?

It will ultimately come down to -- I would say this. If you were to look at our overall projections for the year, we expect somewhere in the range of about two-thirds for this year will be USG and approximately one-third will be DCS orders. That's rough math.

Okay.

The year-over-year margin contribution will somewhat depend but holding everything else constant you're not incorrect it just depends what happens with our DCS order ratio next year for the full deliveries in 2015.

Okay. Yes. That make sense.

Yes. At this stage it's hard to tell but certainly we're comfortable that this is timing and we feel really good about the JPF franchise overall.

Okay. All right. Back on the KIT side of things Neal you talked a little about the monthly progression. Maybe I missed it but did you say by any chance, sort of how the trends is looking in October in terms of a year-over-year sales change?

Yes. Matt. We're down between 2% and 3% through the first little bit of the month.

Okay. And then my recollection is -- and I think you may have a little bit of a sales day difference 4Q this year versus 4Q last year. How many selling days do you have 4Q this year versus last year.

We have 61 days this year versus 60 last year. So we're up one.

Okay. So mid-point of the KIT guide for the year is kind of flat organic sales in the fourth quarter with the benefit of an extra day is kind of the way to think about that. So really the selling -- sales per day down low single digit but you benefit from an extra day. Is that kind of where we're at.

Yes. Yes. The implied range is sequentially flat with the third quarter and about call it between1% to 2% down relative to prior year.

Yes, I mean the comp is significantly easier in the fourth quarter as well, I think you were down kind of low teens 4Q last year versus down low single digits in the 3Q. So, I know the comp is a little bit easier, but other than the comp is there anything else that's causing the rate of change to the slowdown here? I mean you've been seeing sales declines at KIT call it kind of mid-single digits per day, mid-to-high single digits per day for most of this year. Is it just that easy in comp or are you seeing business trends that are making you a little more optimistic?

Yes. I mean part of it is clearly just on the year-over-year basis is the easier comp from last year but really part of what's driving this as well is on the AC&E product platform we are expecting an uptick just based on what we have in backlog. Now some of that did get pushed into 2017 as we talked about in our prepared comments but the overall product platform is expected to show a pretty positive fourth quarter and then really just expecting stabilization elsewhere in the business. I mean what we are seeing on the fluid power side is we're feeling increasingly comfortable--along the bottom here in particular on fluid powder product and then in our other bearings and power transmission we're just seeing some stabilization.

Okay.

In the fourth quarter.

Okay. Very helpful. On segments margin there you guys talked about some of the costs flowing through on the productivity initiative. It sounds like most of that's going to roll-off by year-end. So how do we any about the impact on segment margin on a year-over-year comparison basis? How many basis points of margin are you going to pick up by benefiting from the benefits of those actions without those being sort of overshadowed or at least canceled out at this point by the cost of taking them.

Yes. No. That's an excellent question. We do expect as we enter into 2017 for the majority of these costs to begin to diminish. So I mean if you were to do the math which I'm sure you have based op numbers we have provided I think you are looking at somewhere in the 50 to 70 basis points range is certainly fair holding everything else constant.

Okay. Fair enough. The last thing for me just on the corporate expense coming in a little bit low if I understand correctly there's kind of three things your employees were healthier so that's obviously a good thing. You guys seem to be managing costs a little bit there because you mentioned overall expense management and then there's lower incentive comp. I look at where corporate expense came in versus where it was implied to be an a quarterly run rate in guidance and it's about $3 million below. Is there any way you can help us think through kind of how each of those items impacted that line item this quarter?

Yes. I mean I don't want to get into too much specifics, Matt, but certainly on the healthcare side we did see a pretty meaningful variation to the positive and HR team some credit here we have been putting wellness initiatives in place for some period of time and certainly we hope that's translating into the improved experience. As it relates to the incentive comp I would argue that a, call it 20% to 30%, of that healthcare not too dissimilar percentage and the rest is really flat out expense control where we have some discretion on some of our corporate expenses but certainly we expect us to carry through the balance of the year. Some of these items may or may not carry into 2017 as we start -- we start thinking about next year and we'll have more color on that in the next call.

Okay. Perfect. Appreciate all the color. Guys. Thanks.

Certainly. You're welcome.

Thank you. (Operator Instructions). Our next question comes from the line ever Chris Dankert Longbow Research. Your line is now open.

Good morning guys. Thanks for I can take my questions.

Good morning, Chris.

Good morning.

I guess first off with the K-MAX program , can you just give us any color at all about kind of the shape of the year for those deliveries as those begin to rollout will we see those already in the first quarter or will that be more of a back half type of thing and just any update on -- on order transfer interest in the program?

Chris, it's Neal. I think that we will begin delivering aircraft to customers in the first half of next year probably late first quarter, early second quarter we would anticipate and I believe that we're planning to turnover about four aircraft next year over the course of the year and -- and be on a cycle of about one every other month from that point. So that's -- that's how we're viewing it right now. Obviously, there may be a little bit of the shift one way or the other simply because these are the first aircraft that we have built-in a while and the first two are going to a new customer in China. So there may be a little variation there in initial deliveries, but we feel good about where we are in the program right now and actually we had an update just Wednesday of this week. A lot of activity right now primarily in Europe and Asia for the aircraft, but we haven't -- we can't report that we have signed any additional firm orders. We believe we are close with a couple and hope to have certainly some positive news either on the fourth quarter call or -- or if it's significant enough with a press release between now and then.

Great. Great. Thanks. And then I guess kind of similar vein any update on just the progress working with Egyptian military on their newly acquired SH-2?

Well, we've -- we continue to work with them. We're working with both Navair and the Egyptian government on that. I think I probably feel most comfortable, Chris, leaving it at that point, right now. The final configuration of the aircraft is really what they're working through. What equipment they need to have on it, what the current state-of-the-art if you will on that equipment is both for availability and also for sale to Egypt.

Okay. That's very fair. And I guess kind of lastly moving over to KIT looking into fourth quarter I guess you guys had kind of anticipated some flat oil and gas activity in the third quarter. I guess what are you kind of baking into fourth quarter? Are you expecting further incremental declines in oil and gas in the fourth quarter are you expecting things to be more flat I guess just some color there would be helpful.

Yes, Chris. This is Rob. As it relates to the oil and gas and mining we are forecasting relatively flat sequential quarter-over-quarter performance there. We're not expecting any large uptick or downtick and I think similar to what a number of others have reported I think the third quarter came in weaker than most expected certainly if you have downstream exposure. So we're expecting flat.

Okay. Great. Thanks again so much guys.

Thanks, Chris.

Thank you.

Thank you. Our next question comes Shannon Burke of Gabelli. Your line is now open.

Hi Neal, Rob. How are you?

Good, Shannon. How are you today?

Good Shannon.

Thank you for taking my question. So just on KIT if my math is right with the actions you have taken place we should see margins above the 5% level in 2017 even if volumes stay flat, correct?

Yes. No. I think that's a very fair assessment, Shannon.

Okay. So if volumes -- how much of an uptick in volumes would you need to get to that 7% goal would you say?

Well, I would -- I would say, Shannon, it would be difficult to see a scenario in 2017 certainly, where the volume would uptick enough. That would be great if it did, but if you think about the general rule of thumb that we talked about, and this goes back a number of quarters-- typically organic growth drops to about a mid-teen range give or take.

Okay.

And I don't have the exact math in front of me what we would need to get to 7%, but certainly I think you would definitely need to see a -- a more robust demand environment for us to get there. These initiatives that we've talked about do have a significant impact and certainly move us in the right direction given the demand environment that we're in. So we're certainly much better position from a cost perspective and then operational perspective to get there than we had been, but we -- we need a little bit of help from the market here for sure.

Okay. Great. Thank you. And then on Aerospace so the margin has bounced around a bit this year. How should we think about 2017? How long are you -- will amortization charges last and confident are you in getting that DCS shipment in is it because it's a new customer? And then also if you could touch on the operational issues if that's still having an effect on the margin.

You know, I'll start, Shannon. The JPF-- we're very confident in the JPF shipment that is shifted out of the fourth quarter of this year into -- into 2016. It is -- it is a -- an existing customer that we have provided product to for a number of years, a very good US ally. It is just again as we said the political environment right now with very few foreign military sales or direct commercial sales in this case being approved.

Okay.

Yes, and then Shannon just addressing your other question, we experience and we do anticipate $5.5 million of integration cost and inventory step up relating to the acquisitions, those will certainly drop off. They already have begun to if you look at our adjusted profile we incurred about $0.5 million in this quarter. We expect about another $600,000 to $700,000 in the fourth quarter to get to $5.5 million. In terms of the amortization there is really, there are two pieces there Shannon. I mean there's the amortization that the acquisition kind of brought with them so to say, those would be expected to continue. We continue to invest in certainly CapEx and other things in that business. The other piece relates largely to the intangible amortization and those will go on for a period of years and then they are typical amortization periods you know call it 10 years to 12 years give or take. So, that drag which is probably in the $1.5 million to $1 million range we would anticipate going out through our forecast period.

Okay. Great. Thank you. And then the operational issues is it still hurting the margin or is it just something that's going to affect your full year because of the Q2 --

You're speaking significantly to the structures. We continue to work on that as Neal touched in his comment we're pleased year-to-date with the progress we have made in addressing those issues. So we would expect that to be predominantly a 2016 issue.

Okay.

Certainly in 2017 we'll provide more color as we enter into the year-ends call.

Okay. And then just lastly on the K-MAX you commented that commercial -- or MRO flight hours were -- were down. Is this something that you think is just a one-time thing or is this sort of a change in the market and how the K-MAX is being used?

No, Shannon. We view this as a one -- likely a one time or infrequent event. The way that many of the firefighting contracts are let, Shannon, is that the -- our customers contract ahead of the fire season and their aircraft are positioned in certain locations. As it turned out last year we were positioned in areas where they flew a lot and this year interestingly enough the fires were -- were not predominantly in the areas that -- of coverage for our aircraft. So it was, we kind of scratched our head a little bit as well and then it became obvious to us what the issue was that was impacting the flight hours and then directly back into the -- the business that we're able to do on an MRO basis or overall basis. So we view that as an infrequent event rather than a trend.

Okay. Great. Thank you so much.

Thank you, Shannon.

Thanks, Shannon.

Thank you. (Operator Instructions). Our next question comes from the line of Robert Kirkpatrick Cardinal Capital Management. Your line is now open.

Good morning.

Morning, Rob.

Just a point of clarification. In your 10-Q in the outlook section it mentions that the adjustments to the operating margin outlook for Aerospace is due to the under performance on the structures programs and not due to the JPF. Would you like to take the opportunity to kind of straighten the record?

Yes. No. Rob, I appreciate that. And certainly you're correct that the Q would have indicated the structures was the larger contributor. Certainly as we got close to the quarter we recognized that with the DCS orders not taking place that the larger contributor to the operating margin really relates to timing on DCS. There was some impact clearly the MRO business that we touched on the structure side has a nice margin with it as well and that's certainly impacted but certainly the greater impact related to DCS being pushed out. On our the topline certainly the structure -- some of the structures timing there had a meaningful impact in being pushed out whether it's Peru some of the MRO work and then also we had some timing on AH-1Z deliveries. So the structure side took the larger slice of the pie on the topline and DCS on the bottom line. So certainly that's really what's happening under the surface.

Great. Thank you very much. And then a couple other questions. One can you provide us with any update on a program of record for K-MAX?

Rob, we -- we don't have any update on that right now. We continue to as we have said in -- in prior quarters we continue to work that with the Marine Corps. We anticipate -- we understand that there's going to be additional funding for the aircraft to operate in Yuma and add some capability to it in the upcoming year. As we continue to work through adding some of the additional capability that will make it easier for the Marine Corps to move it into a program of record, but we do not have a time frame that we can talk about right now.

And the additional capabilities do you feel comfortable discussing those?

You know, Rob, what -- what they would like to do is to have more than a -- a single mission aircraft. General Davis who is the Assistant Commandant for the Marine Corps for aviation really wants to have multi capability platforms because it enables him to have more flexibility as they develop the concept of operations. So what they have talked about is ISR. So that you can -- you can trade cargo for fuel and have a longer loiter time and provide surveillance capabilities. They've also talked about some limited arming of the aircraft as well so that it could provide to put metal on a target if required. So those are the kind of additional capabilities that -- that they're asking us to work through. We have done things with as you know, already with beyond light of sight communications and now we've also got real-time video capability on the aircraft as well. So we continue to make progress there, but those are the kinds of capabilities that they're looking to add to the K-MAX and the reason that they're striving to add those capabilities.

And on the firefighting side in terms of the US forest service can you provide any update on that with respect to unmanned K-MAX.

Yes thanks Rob. I'm glad you asked that question because we probably should have included it in our prepared remarks. We actually have a upcoming demo next month at Griffiss Air Force Base, the old Griffiss Air Force Base, in New York with unmanned firefighting demonstration that was requested. If you remember Griffiss is where we did the initial demonstrations, now about almost two years ago I guess but we -- we have been requested by the -- the Department of the Interior for an additional capabilities review and that will take place next month.

Great. And then finally could Rob provide a little more detail as to what the $8 million to-date has been spent at KIT on in terms of the productivity initiatives revolving around process improvements and data analytics. Is it more labor, is it software that you have bought that you have installed? Help me understand that a little bit better if you could, please.

Yes. No. Rob, good question and I'll give you some additional color there as we can. It really is a combination of costs that we have incurred in this initiative. We have certainly invested in the data analytical side in IT, software, certainly systems capabilities in order to provide the field with a decision tool support that they need. We've also in order to accelerate the rollout we have engaged both outside and have increased internal resources to really expedited the rollout of the program given the effect that it has on the performance. So it's a combination and we're very pleased to-date with the effect that it's having on the business.

Great. And the 50 to 70 bps improvement all the other things being equal that you mentioned earlier is a combination of the costs of the implementation going away and the receiving the benefit from it ; is that correct?

You know, Rob, I think that is correct, but I would say a lot of that is really just based on the cost going away holding everything else constant and holding the gains that we've got to date.

Okay. Great. Thank you so much. I appreciate it, gentlemen.

Thank you, Rob.

Thank you our next question comes from the line of Ryan Cieslak of KeyBanc Capital. Your line is now open.

Hey, guys. Just a really quick follow-up if I may. In the distribution segment you guys went through some cost actions earlier this year and I know it seems like the topline has been weaker than your expectations. Are you guys sorry if I missed this, but are you guys looking at additional cost actions as we look for the balance of the year or how do we think about maybe again your some opportunities on the cost side considering the topline has been weaker than what you had expected?

Ryan, you know, we -- we did have some additional reductions in the quarter relatively minor. The big reset was in the fourth quarter of last year we have seen a lot of that benefit flow through and I think we did a pretty good job at that point in time to size the business to where it needed to be for the -- the volume and in particular when you consider as Rob just talked about some of the additional staffing that we added to be able to support our productivity initiatives so, we would not expect given where we are today any additional impacts on our staffing levels.

Okay. And then just really quick last one for me. You know, some of the headwinds you have seen on Aerospace on EBIT from the changes and your contract estimates this year how do we think about that going into next year? Does that become a tailwinds or is that headwind roll-off or is it just at the end of the day hard to really identify just based off of where you guys are with the program.

Yes. Ryan, good question and I'll start and Rob can chime in. if you were to look back over a five year period of time on average we've had about a $1 million negative EAC adjustment, but it does vary significantly from year to year. So we would like to believe that we have got those behind us because it comes with the EAC accounting as well. Sometimes you will see those larger chunks because you have to take a -- a -- all of your adjustment is within the period. So you have to essentially have a true-up for both retrospectively and prospectively so we -- we believe that we should have those certainly current and without a degradation in operating performance should be okay from year to year, but all-in-all , you know, it's been a -- a significant change from year to year. You are absolutely right. Part of that is driven by the favorability that we had last year was -- was better than -- than we historically had. So it's one of those that -- that you wish was more on average over the two years rather than the divergence but it's just how the programs roll and the appropriate accounting for how we incur the costs and predict future costs.

Yes. Ryan, I would just make one other comment as it relates to what to anticipate in the future. I mean, certainly how we perform on the programs relative to the expectations we have built today will play an important role in any future EAC adjustment for the plus or the minus. The other thing to keep in mind and this is going out even beyond 2017 is as we think about the upcoming revenue recognition standard changes that will certainly have an impact as well on EAC accounting. We will have probably some level of programs that may not today be EAC accounting that may fall into the EAC accounting. So we would anticipate that to become a more important feature as that standard gets implemented in 2018. But that's a ways off. Just something to think about.

No. That's all really good color. I appreciate it guys. Best of luck.

Okay. Thank you, Ryan.

Thank you, Ryan.

Thank you. Our next question line ever Robert Kirkpatrick of Cardinal Capital. Your line is now open.

Sorry. One more. With the convertible debt becoming current as a result of the price at which the stock traded at do you want to talk about potential options you are examining to take care of that maturity if that comes up in 2017?

Yes, no. Rob. Excellent question. The notes for the fourth quarter are convertible at the option of the bond holder. We certainly do not anticipate anyone presenting the bond. Just given the corporate finance aspect of it. We would be very surprised to see anyone but we're prepared for that should someone elect to convert their bonds during the quarter. As it relates to the capital structure side we are certainly evaluating our refinance options. We do have another year in which to do this. The rate environment has remained favorable. I know rates have picked up a little bit in the last few weeks but the convertible bond market or other capital market options available to us are very robust at this stage so we have a lot of options. Certainly I would anticipate some time in 2015 in advance of maturity we will certainly look to address the upcoming convertible maturity.

Great. Thank you so much.

Okay. Thank you Rob.

Thank you I'm showing no further questions at this time. I would turn the call back over to Eric Remington for any closing remarks.

Well, thank you for joining us for today's call. We look forward to speaking to you again when we report our fourth quarter results in February.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may disconnect. Everyone have a great day.