Kaman Corp (KAMN) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kaman Corporation First Quarter 2018 Earnings Conference Call. (Operator Instructions) And as a reminder, this conference call is being recorded. Now I would like to turn the conference over to Jamie Coogan, Vice President, Investor Relations. Sir, you may begin.

Good morning. I'd like to welcome everyone to Kaman's First Quarter 2018 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, I'd like to note that some of the information discussed during the 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 first quarterly report on Form 10-Q 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. Reconciliation to the company's GAAP measures are included in the earnings release filed with yesterday's Form 8-K.

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

Thank you, Jamie. Good morning, and thank you for joining us on today's call. I'd like to begin today with an update on each segment before I turn the call over to Rob to discuss our financial results and to review our updated outlook for the balance of 2018.

Starting with Distribution. Sales growth in the first quarter has continued to improve with sales per day up 4.5% over the prior year and 4.6% sequentially. We saw increased sales in 7 of our top 10 end markets, led by machinery manufacturing, transportation, food and mining. We were pleased to see a step up in sales volume across the business, especially in light of a relatively modest increase in sales from our national accounts. However, we have won several new national accounts, which carried some near-term costs as we onboard these new customers. Although it takes time to transition these accounts, we expect a slight benefit in the second quarter, which will then ramp up more significantly through the remainder of the year.

Additionally, we saw a $12 million increase in our backlog. And when coupled with our National Account activity, this provides us a positive backdrop to the balance of the year and helps position us to drive continued revenue growth.

Turning to Aerospace. Results for the quarter reflect strong performance on a number of our military and defense programs, offset by a decline in our commercial programs due to lower K-MAX sales and 777 structure sales as this legacy commercial platform transitions to the next generation design.

We have been successful in securing applications on a number of new platforms that position Aerospace for continued growth in 2019 and beyond.

Moving to our largest program, we delivered over 3,900 JPFs in the quarter with approximately 3,600 of the deliveries associated with DCS contracts. We still expect to deliver between 34,000 to 38,000 fuzes during 2018 with a significant portion of these deliveries going to satisfy our U.S. government requirements.

While we benefited from the favorable DCS mix in the quarter, the higher mix of U.S. government sales for the full year will put modest pressure on Aerospace operating margin performance.

Interest for the JPF remains strong, and we're in the process of negotiating new contracts that would significantly expand the order book for this product.

During the past few years, we've made considerable investments in support of our Specialty Bearings and Engineered Product offerings. These investments in advanced machine tools, robotics and automation have allowed us to lower our production cost and reduce our lead times. And in 2018, we will open a new state-of-the-art test facility that will enable us to reduce our time-to-market, while allowing our engineers to design and test new products for next-generation applications and platforms.

And over the past number of years, we've worked to expand our relationship with Airbus and have increased our content on a number of aircraft.

Recently, we held a celebration on our Bloomfield campus in honor of our selection by Airbus as a strategic technology partner, underscoring the capabilities we bring to our customers and helping them to meet their most challenging applications. We're proud to have been recognized by Airbus and look forward to continuing to expand this relationship.

For our Composite Structures programs, we continue to make progress on the restructuring and transition steps we announced last year. Cost for these actions weighed on Aerospace margin performance for the quarter and are expected to be weighted to the first half of the year. We expect benefits from these actions will increase as we move through the year reaching full rate -- run rate in 2019. Driven by the successful execution of our most recent JPF contract, Aerospace backlog grew to over $800 million at the end of the quarter. This high watermark for Aerospace positions us well for the future by providing critical backlog and programs like the JPF, BLACK HAWK, AH-1Z, K-MAX and across our Specialty Bearings and Engineered Products lines.

Before passing the call off to Rob, I wanted to spend a moment talking about our acquisition strategy moving forward.

The quarter saw a significant increase in cash flow compared to the prior year and when combined with our stronger cash flow generation in the latter half of 2017, we have significantly reduced our debt load, providing increased flexibility to execute on our acquisition strategy. We are evaluating potential targets focused largely on our aerospace business, which would enhance our Engineered Products offerings while leveraging our current capabilities to help drive synergies.

As we move through this process, we will remain disciplined in our approach to evaluation, mindful of our internal return on invested capital metrics.

And now, I'll turn the call over to Rob. Rob?

Thank you, Neal, and good morning, everyone. I will begin today by touching on the change in revenue recognition accounting, which is reflected in our results for the quarter before moving to our performance and finishing with an update on our outlook for 2018.

We adopted the new revenue recognition standard at the start of the year, and our first quarter results reflect the adoption of the new standard with prior period results still accounted for under the old revenue standard. I would like to take a moment to discuss how this affects our results.

For Distribution, the method of revenue recognition remains substantially the same and the impact for the quarter was relatively immaterial.

For Aerospace, the impact was more significant. Prior to the adoption, we recognized revenue on a majority of our long-term contracts using units of delivery as a measurement basis. Generally speaking, this means that we recognized revenue upon the delivery of our products to our customers.

Under the new revenue standard, we now recognize revenue on a majority of these contracts when costs are incurred as work progresses on a program prior to the delivery of the product to our customers.

It is important to note that while the adoption of the new standard impacts the timing of revenue recognition, it does not affect the total amount of revenue we will recognize on these contracts or the timing of cash received or payments related to these contracts. So what does this mean moving forward?

The programs with the largest impact on our results from this change are our JPF, USG program and our K-MAX program. Our JPF, USG revenue recognition will be smoother quarter-to-quarter as we recognize revenue as costs are incurred on this program, eliminating the volatility that we had often experienced in the past when revenue was recognized only upon delivery to our customer.

Importantly, the new revenue recognition method better aligns with the economics of this program as we receive progress payments from the U.S. government as cost is incurred.

For the first quarter, this meant that we recognize revenue on our JPF Option 13 program prior to delivery. For K-MAX, we will now recognize revenue upon transfer of title to our customer, moving away from a model, where revenue was recognized as we made progress on the aircraft prior to delivery.

In the current quarter, this meant lower K-MAX revenue as we recognized revenue on one aircraft delivery during the quarter.

The increase in operating income associated with the adoption of the standard in the first quarter was $9.7 million, which, as noted above, is primarily related to timing. As a reminder, we prepared our 2018 outlook under the new standard and anticipated it would result in an increase in operating income for the year as highlighted on our fourth quarter call.

Please refer to our Form 10-Q filed last evening for a more detailed discussion related to the adoption of the new revenue recognition standard. With that said, let's move to the results for the quarter.

Consolidated sales in the first quarter increased 6.3% to $463 million as sales increased at both segments and benefited from favorable foreign currency exchange rates. Diluted earnings per share of $0.50 included the impact of restructuring and severance costs incurred in the quarter. When adjusted for these items, we achieved adjusted diluted earnings per share of $0.55 compared to $0.22 in the prior year. The increase in diluted earnings per share is the result of profit recognized on our JPF, BLACK HAWK and AH-1Z programs.

Additionally, earnings for the period benefited from the significant reduction in our effective tax rate and the improved performance we delivered on our pension plan.

Aerospace sales increased 9.2% to $179.4 million compared to $164.3 million in the prior year period. Sales for the quarter included a higher mix of JPF DCS deliveries and an increase in USG, JPF revenue as we began recognizing revenue under Option 13 of our USG contract.

Additionally, we saw an increase in Specialty Bearing product sales, primarily related to higher volume for our miniature bearings and our PMA offerings. Operating margins for Aerospace were 12.6% -- or 13.6% when adjusted for the $1.7 million of restructuring and severance expenses, a 380 basis point increase over the prior year. We expect improvements in Aerospace margins as the contribution from our Specialty Bearing products increases in the second half of the year. At Distribution, our sales increased 4.5% to $283.9 million compared to $271.6 million in the prior year period. Daily sales for the quarter totaled $4.436 million per sales day, a 4.5% increase over the prior year, representing our highest daily sales rate since the second quarter of 2016.

We saw growth across all of our product platforms with the most notable increase coming from our bearings and power transmission products. First quarter operating margin performance of 4.2% was in line with our expectations.

As is typical, the first quarter margins were disproportionately impacted by certain employee-related costs, such as payroll taxes, vacation and 401(k) expenses. The impact from these costs lessens through the year contributing to higher margins in subsequent quarters.

Before I move to a discussion of our cash flow performance for the quarter, I want to touch on the change in the accounting for pension-related income and expense. As discussed on the fourth quarter call, changes in the accounting for these items resulted in their reclassification of approximately $3 million of pension expense for the quarter below the calculation of operating income. This reclassification lowered operating margins for Distribution and Aerospace by approximately 30 basis points and 110 basis points, respectively, from what we would have disclosed under the prior accounting treatment.

Absent this accounting change, Distribution would have delivered a 4.5% operating margin, while Aerospace would have delivered an operating margin of 13.7% or 14.6% when adjusted for the restructuring costs.

Our cash flow from operations were $56.9 million compared to the prior year period use of cash of $18.5 million, a $75 million improvement. This led to free cash flow of $50.5 million, which we used to pay down debt, reducing our leverage ratio to 2x the low end of our long-term range.

With the increased availability under our revolving credit agreement and the anticipated cash flow performance for the year, we have ample financing capacity to execute on our acquisition strategy.

Moving to our outlook. We continue to expect sales at Aerospace to be in the range of $750 million to $780 million with operating margins of 15.5% to 16.0% or 16.2% to 16.7% when adjusted for the approximately $5.5 million of restructuring and transition costs.

We are increasing our expectations for Distribution sales by $10 million for the year due to the anticipated ramp in sales from national accounts. We now expect sales in the range of $1.11 billion to $1.16 billion with operating margins in the range of 5.1% to 5.4%.

We are increasing our expectations for income from our defined benefit pension plan by $1 million to $12.5 million, as assumptions underlying the previous calculation have been finalized.

In April, we announced $2.6 million of onetime employee incentives. This expense was not previously contemplated in our prior 2018 outlook. Despite this, the performance of the segments in the first quarter provides us confidence to hold our prior expectations for operating margin, effectively raising our expectations for the underlying performance of our segments for the year.

In addition, we elected to contribute an additional $10 million to our pension plan, which will receive a tax benefit at our 2017 effective tax rate.

Taking this additional contribution into consideration, we're still maintaining our expectations for cash flows from operations at $185 million to $210 million or free cash flow of $150 million to $175 million. As we mentioned last quarter, over the last 4 years, our free cash flow conversion has averaged 127%, well above our long-term goal of 80% to 100% of net earnings. We expect this to continue through the balance of 2018. Moving to the cadence of earnings for the year. We still expect approximately 70% of our earnings in the second half of the year.

With that, I will turn the call back over to Neal.

Thanks, Rob. I'd like to thank our investors for their interest and support as well as the dedication and commitment of our more than 5,300 employees for delivering world-class products and services to our customers every day.

Now I'll turn the call back over to Jamie. Jamie?

Operator, may we have the first question, please?

(Operator Instructions) And our first question is from Edward Marshall with Sidoti & Company.

So with the adoption of 606 and the JPF timing, the smoothing, I'm curious why still the 70-30 split through the remainder of the year? Is there something specifically weighing on the margin in 2Q? Or is the rest of that large -- and secondly, is that rest of that large DCS order, was that shipped in Q1?

Yes. So a couple of things. The DCS -- this is Rob. The DCS units that were shipped in the first quarter related to the $93 million order. That was really the remaining portion of that order. In terms of the cadence, you are correct, you might expect there to be more smoothing given the USG calculation under ASC 606. But what's really driving that is a few things. We have the ramp up in our Bearings, which is similar to prior years, where we expect majority of those earnings in the back half of the year. We also are expecting improvement in structures as our restructuring costs in that unit are also front half loaded. And we're also going to see improved delivery of profit from Distribution as well. So when you kind of combine those, those all contribute to the back half loaded earnings guidance.

Got you. Okay. And then timing with distribution margin. I'm curious, you've made some investment, there's new accounts that start at lower margin, but you're seeing some increased volume. I'm wondering, you talked about a build through the fourth -- through the year, and I'm wondering, as we kind of look at the year or maybe the cadence for the year, is the fourth quarter, which typically faces a lot of seasonality, still anticipated to be your strongest quarter for the year? Or is the tail off in Q3 is more of the strongest? Just...

I would expect that the third quarter would probably be the strongest, Ed, in particular, as you noted. We've had cost on board. The accounts during the first quarter, we expect to see some incremental volume from them start in the second and ramp up in the balance of the year. But third quarter, I would expect would likely be the strongest and then even though, we would like to look at continued volume growth in the fourth quarter, just with the holidays that fall in the fourth quarter, it gets a little bit harder to absorb that fixed cost.

Okay. And I'm curious, I think, it was Rob, you mentioned that you saw the strongest in the power side of the business, the bearings and so forth. I'm wondering some of the longer lead time items, such as electrical automation, maybe some of the stuff that B.W. creates. Are you seeing the orders? Are you seeing the revenue flow? Has it picked up yet? I'm just kind of get a sense for the strength that you're seeing within Distribution.

We're seeing pretty good strength in orders, Ed, and as we noted, we added about $12 million of backlog, which was a little bit higher than normal for us through the quarter. So if half of that had flowed down to shipments during the quarter, we would have been in between 6% and 7% organic growth. So we've seen the orders, but some of our suppliers are struggling a little bit, catching up and then we had some past dues that are on us as well.

Final one for me. How are you managing freight inflation?

Yes. In terms of freight, Ed, that does continue to be a focus of ours. We are certainly seeing that. Certainly, rising fuel prices will contribute to increased freight. So we are managing that very closely and the team is certainly aware of the changing dynamics that we're seeing in freight. We're focused on it.

Our next question comes from Pete Skibitski with Drexel Hamilton.

Just on the distribution side, the growth there, you talked about the national accounts. Are you feeling any acceleration in the underlying economy in the U.S.? I'm just curious for Distribution if tax reform is kind of giving you a distinct tailwind or if it's just more sort of national accounts onboarding?

Pete, to this point in time, through the first quarter, it is not national accounts. In fact, we were down slightly from year-to-year. We had -- it was lower growth -- excuse me, lower growth in national accounts than last year. So we really anticipate our new national accounts will begin contributing to volume in the second quarter. I don't know if we can relate it specifically to tax reform, but we are seeing clearly strong ISM numbers well above 50%, in fact above 60%. We're seeing some uptick in industrial production. So I think part of it certainly is the manufacturing economy is recovering. And certainly, we're glad to see that and glad to be participating in it right now.

Yes, it sort of feels better too than it has in several years because, obviously, it's been a while since Distribution had a real top line organic story going for it.

Yes. We do feel a lot better about it, Pete. And also we look at the daily cadence and it's relatively consistent, which is also a good sign for us. Occasionally now we will see the pop-up in a daily rate because of a larger order for capital expenditures and capital equipment that we might be providing or supplying too. But the consistency of orders from day-to-day is much better than it's been for us recently.

Got it. Okay. And, guys, I just want to ask on the JPF. You booked a $324 million order, and yet you're still saying that there's more significant new opportunities, which is a nice statement there, I thought, given what just happened. So any color -- I know it's probably sensitive to some degree, but anything you can add in terms of timing of these type of new orders and relative sizing?

I'll tell you about -- we'll break it up into 2 parts. The first are U.S. government orders. We -- as you know, we closed on Option 13 in the fourth quarter of last year, which was originally $85 million with a plus up of an additional $17 million for just over $100 million total. We anticipate the receipt of Option 14 in the second quarter or early third quarter. That would -- we anticipate would be roughly in the same size range, so $85 million to $100 million. In addition, late last year, the U.S. Air Force also announced that we would be awarded Options 15 and 16, and they anticipated likely in the same range. So we would anticipate those being awarded later this year. And that was stated to be a sole source from Kaman. So on the USG side, we see somewhere between, let's call it $250 million and $300 million there, which we're very pleased with, and we continue to work with a number of foreign governments for direct commercial sales. We've had good luck with those recently and we think earned our position both by the capabilities of the product, the quality and reliability of it in service, and also the ability to deliver. So we are -- I think we remain confident that we'll be able to continue to expand our DCS order book.

Our next question is from Ryan Cieslak with Northcoast Research.

I guess, first on Distribution, just to be -- wondering if you could give some color on how the quarter progressed. I think, Neal, last conference call, you'd mentioned sales were up in that 5% range through February. Maybe just how March played out? Obviously, it looks like maybe that dipped down a little bit based on the way you finished the quarter. And then, just how April trended as well on a year-over-year basis?

Sure thing, Ryan. Actually, I think that when we look at the cadence through the first quarter, we were actually up 12% from January through March. But the comps got tougher. And in fact, April was our best month last year, and we're fractionally up quarter-to-date. So we were -- we've maintained a pretty strong incoming order rate, which we're pleased with. And actually, we did have a nice sequential increase, although February weakened in the second half of the month from -- after we had our conference call.

And was there anything specific to that, Neal, in terms of where you saw the weakness? Or it was just something that you guys typically would see at that point of the quarter?

Yes. I can't say that we could point to any one thing, Ryan. And it did tick back up nicely in March and has maintained that. So we're pretty pleased with where we are right now and that's really what led us to increasing our outlook by the $10 million for the balance of the year.

Okay. And the comps in May and in June get easier than relative to April for you guys?

They do. That's right.

Okay. Great. And then, just any comment maybe you can provide on pricing within Distribution right now? What you're seeing there? Maybe the impact that it's having right now on your price cost spreads and how that might play out and trend for the balance of the year?

Ryan, we continue to believe that price could impact us between 1% and 2% over the course of the year. Obviously, we're beginning to see a few price increases now. I think we will see more in the July time frame. So probably, we'll have a much better gauge of that in our second quarter call than right now. But from what we see, we think it should be 1% to 2%. We would expect a little margin squeeze early and then some benefit from that later in the year.

Okay. Got you. And Neal, can you maybe just quantify or give us some additional color on the size of these National Account wins and maybe the incremental contribution it can have to sales for you guys or growth. Just to sort of help us with maybe the cadence of the ramp and maybe also the cadence of the incremental margins going forward?

Ryan, for competitive reasons, we're not going to go there. I appreciate the question very much. If I were you, I would ask it, but if you were me, you wouldn't be answering it.

Fair enough. Fair enough. And then a couple of last ones here. It's going back to the question asked about the split in earnings for the year and the cadence. I think basically the 30% in the first half of the year implies a pretty big step down in earnings from the first to the second quarter. I guess a lot of that has to do just with, again, the timing of the JPF shipment here in the first quarter. But any sort of color you can provide, Rob, on just how do we think about Aerospace margins sequentially from the first to the second quarter? It feels like those need to step down I just -- maybe would help us out just again, thinking about and framing it up in terms of maybe what's really impacting the drop in earnings from first to second?

Yes. Ryan, good question. A couple of things. We do use the word approximate. So the 70% is approximate. In terms of margin expectations for Aerospace, we really don't see a notable decline in the second quarter. And we do clearly expect that to -- the margin in Aerospace to improve significantly as we move through quarters 3 and 4, as we deliver under Bearings and as we see improvement. We also have the restructuring costs that are front-end loaded, as I've mentioned. So to answer your question, margin-wise, we're not expecting a meaningful degradation in the second quarter at Aerospace. Certainly, in terms of attribution, we would expect to see perhaps a slight reduction in sales just based on timing in the second quarter at Aerospace, but once again, nothing all that material. So it's really more a question of just the relative ramp that we see in the fourth quarter relative to a meaningful degradation.

Okay. So maybe there is some -- It sounds like there's some conservatism ultimately baked into how you're thinking about how the second quarter plays out and relative maybe to the rest of the year as well?

Yes. I think we're trying to provide a rough framework in terms of the earnings cadence because given what we've seen and what we're forecasting. But we certainly think that the Aerospace we're expecting pretty decent performance in the second quarter.

Okay. Great. And then my last one. You guys mentioned about some investments in production capacity at Aerospace. Is there any change the way you view about your ability to potentially deliver or have sales being pulled forward in Aerospace as your capacity is ramping? Or maybe what does that do to your ability, obviously, to realize maybe some of the sort of backlog sooner for you guys going forward?

Ryan, I think, most of all, we view it as positioning us to continue to support the growth that we see in that business. If customers need product earlier, we have industry-leading lead times, so we're able to serve that. It is a little bit interesting even to us that the fourth quarter is as strong seasonally as it is and has been for several years. So I think the most important thing for us in those investments is that it positions us to continue to support the growth in that business. They also allow us to continue to maintain those industry-leading lead times and also maintain a very good cost position so that we can be responsive and hopefully gain share through new applications in the market.

Our next question comes from Steve Barger with KeyBanc Capital Markets.

Were the National Account conquest wins over other national distributors or from local market competitors? And what really drove that win?

Normally, national accounts by definition kind of are, Steve, are one of the main customers of a national distributor. And they make decisions across a very broad range of factors or criteria. We believe that the value-added services that we provide are a very important differentiator for Kaman today. The fact that we can go across the 3 product platforms of bearings and power transmission, fluid power and automation, we think differentiates us as well. And customer service and application experience. So those are the things that we think help differentiate us and win these new national accounts.

How long, in general, do you have to talk to a national account before they'll agree to make that switch? Do you have to wait until the end of the contract? Is it a 6-month selling process? I'm just trying to get a sense for how repeatable it is, and maybe if you have a comment on do you have line of sight to other potential accounts you can take over?

Sure. It typically is at the end of a contract period, simply because they are committed to a competitor. So I would say, certainly, normally at the end of a contract period, we have pretty good visibility on those accounts that we currently don't have and that we would like to add to our customer list and it can be one that we recently acquired was well in excess of 1 year -- 1.5 years for us to work with that customer to be able to be positioned to win and then to actually get it in the win column and begin transitioning that customer to Kaman. So it can be a long process.

Sure. And I understand the sensitivity around not wanting to talk about the size, but can you quantify the margin impact on the quarter from onboarding them? And once those new accounts are up and running, will they have a margin similar to other national accounts or to your full year guidance?

Sure. Steve, in terms of the onboarding costs that we took on this first quarter, about a 10 basis point impact during the quarter. And then in terms of the margin that we would expect, these national accounts are going to be pretty much roughly in line with what we would normally expect across our National Account portfolio. So certainly, largely speaking, we do take a bit of a lower margin in terms of the contracted rate, but we do benefit given the volumes through rebate and other areas. And these are strategic accounts that allow us, as Neal mentioned, to also provide differentiated service across all 3 product platforms. So it's a really good growth opportunity for us.

Sure. Well, yes, and then to that point, I think you'd said that nationals had a lower year-over-year growth rate in the quarter. Why do you think they start to contribute more in the back half or in 2Q? And do you see more growth opportunity with the bigger customers going through the rest of the year or just in riding the cycle with the smaller customers? Just trying to think about how -- where outgrowth comes from.

Yes. So when you think about transitioning a national account, that is a bit of a project, if you will. It takes time to ramp that up because what's really critical to not disrupt your customer. And so we work very closely with the procurement operations of these national accounts. So that's why, even though we've won the national accounts during the transition period, which is why we're expecting more growth in the back half of the year just based on the accounts that we won. In terms of the overall growth, we are seeing growth really across the board, but it is -- the growth is definitely heavier weighted towards national accounts than we would normally have seen in the past.

And a lot of that -- it's interesting because a portion of that is because of our product mix, we have a higher -- when OEMs do well, we have a customer mix, Steve, more towards those OEMs, so therefore, not national accounts by definition. So we had pretty strong OEM growth in the first quarter. So that probably impacted us a little bit as well just on a percentage basis with national accounts being a little bit lower simply because of that.

Understood. And then last question for me. On your comments around Aerospace acquisitions in your prepared remarks, obviously, the various aerospace business units have profit margins that fall across the spectrum. Should we expect to see any acquisition strategy focused on things that are margin accretive to the segment as opposed to looking to get scale and what have historically been lower return business units?

I think that what we tried to convey was that we'd really be focused on our Specialty Bearings and Engineered Products, and we have engineered products in several of our categories today, including our fuzing, memory and measurement and other areas. But I think that you would see us primarily, almost solely, in fact, focused in those areas rather than trying to build additional scale in lower margin businesses.

Our next question comes from Chris Dankert with Longbow Research.

So no, looking at KIT, in the past, you've been looking to kind of optimize some of the margin profile there through pruning. I guess, was there any meaning pruning impact on the first quarter you'd call out?

I don't think that there is, Chris.

Okay. Okay. And then, I guess, apologies, if I missed it, but as far as the K-MAX goes, did you guys officially ship those 3 units in March? Or did any of those kind of slip into -- in April here? Is the plan still 6 units being shipped for the year?

Chris, the plan is still 6 being shipped for the year. You're right, we delivered 1 in March and 1 slipped into April, and the customer that accepted one in March had a second aircraft that he's asked us to -- the one that was delivered in April, they've asked to defer the delivery of the second aircraft to a later time in the year, and we're working with them to work through what that schedule might be right now.

Got you. Got you. I guess, thinking about K-MAX, any other demonstrations, marketing events? Any other big kind of pushes coming up here? It appears we have a little bit of downtime on the fire season.

Well, it's interesting because fire season has actually started already, which kind of surprised us and is, in many ways, unfortunate. But we will actually be with a group just later this week, talking about K-MAX both manned and unmanned. So we continue to believe that it provides a lot of capability both for commercial customers for logging, firefighting, construction, many of the things that, that aircraft has been noted for and differentiated itself for, for decades now. And clearly, for the U.S. Marines, both manned and unmanned, we continue to work that quite hard.

Got it. Got it. And just one more, if I could here. I guess, looking at kind of the broader aerospace market, have you guys run into any broader market issues or bottlenecks, not necessarily Kaman related, but anything slowing down some of the shipments there due to supplies or anything along those lines?

Chris, to this point in time, we haven't. So I know that there's been talk -- there was talk a year ago about some of the issues that the interior companies had. There's been some issues in press recently about some of the fuselage guys in terms of being able to meet the ramp-up rates. But we haven't seen that right now and we haven't seen it in the supply chain to us. So we're ready to take more orders and deliver them. So if anybody wants to do that, we stand ready.

(Operator Instructions) And we have a follow-up from the line of Pete Skibitski with Drexel Hamilton.

The cue, I think, talks about lower gross margin in aerospace bearings. I'm just wondering, is it material, is it steel or aluminum or if it's volume pricing or it's just a temporary issue. Just wondering if you could expand on that?

I think it's higher growth actually in the areas where our margins aren't quite as high. For example, Pete, in -- we've had good growth in our miniature bearings and specialized industrial bearings from the GRW acquisition a couple years ago now. But as you would imagine because of amortization of intangibles, et cetera, those margins come in lower than our -- for example, our self-lube bearing product lines or our K-MAX -- excuse me, KAflex drive shaft product lines. So I think that, that degradation would likely be more so driven by slight changes in product mix.

I see. Okay. Okay. And then a couple more. Rob, can you -- the $2.6 million in employee incentive this quarter. Can you -- I was just going to ask if you could break that up between the segments for us?

Yes. No, a couple of things. First, that impact, Pete, will really be split between the second and third quarters. So there was no impact in the first quarter relating to the employee incentive. And then rough order of magnitude, it's roughly 50-50 between Aerospace and Distribution.

Got it. Got it. Okay. Okay, that's helpful. And then, the offset agreement for the big JPF DCS contract. It's pretty sizable. I'm just wondering how you guys are thinking about achieving that? And if there could be -- is that has the potential to degrade margins or not?

Yes. Pete, good question. As it relates to the offset, first thing I would say is these agreements are fairly common in these kind of contracts. So there's really nothing that I would is atypical about it. In terms of achieving, our team is currently working with the customer to develop an agreement that would enable us to meet that. In the contract, the maximum penalty that should we not achieve any of the offset obligations, that maximum penalty would be about $16 million over the life of the contract. We're certainly working towards developing one that allows -- keep in mind too, the way that the offset agreement works is that, depending on the type of activity that we engage with, they get different levels of credit, if you will, or multipliers. So even though with a $194 million offset obligation, that's a notional value. So there are many, many options that are available to us in terms of how we meet that and we're working toward reaching an agreement.

Okay, that's helpful. That's helpful. I appreciate. Last one, maybe for Neal. Neal, during the quarter, you guys announced some capital investments at Vermont Composites. Was that sort of efficiency related? Or are you seeing higher volumes coming through there that side?

Yes. You're exactly right, Pete. It primarily was new autoclave equipment that we're putting in to support the ramp up on a Rolls-Royce program. And as you know, we also are moving work into our Wichita and Vermont facilities as we consolidate our composites capability. So we wanted to make sure that we had adequate capital equipment to support that work transfer as well as the ramp up on Rolls-Royce.

And we do have a follow-up from the line of Ryan Cieslak with Northcoast Research.

Just really 2 quick follow-ups. First, Rob, the 10 basis point impact from the onboarding cost and distribution in the first quarter, is that ongoing a little bit into the second quarter? And if so, was it just the assumption that the sales start to ramp more and overcome that going forward?

Yes. No, I think that's exactly right, Ryan. We would expect to see continued costs relating to the onboarding of the national accounts through Q2 and even probably a portion of Q3. But as those sales begin to ramp, certainly the margin contribution from those sales will outweigh the upfront onboarding costs.

Okay. Great. And then my last one is, just any update you can provide on the implementation of the ERP within Distribution, I know that's been delayed. Is this something you guys plan to start to kick start again here in the back half of the year? Or how do we think about the timing of that going forward?

I think that's correct, Ryan. We anticipate the next upgrade being deployed in the second half of the year.

And ladies and gentlemen, this concludes our Q&A session for today. I would like to turn the call back to Mr. Jamie Coogan for his final remarks.

Thank you for joining us on today's conference call. We look forward to speaking with you again when we report our second quarter results.

And with that, we thank you for participating in today's conference. This concludes the program and you may all disconnect. Have a wonderful day.