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Edited Transcript of KAMN earnings conference call or presentation 9-Aug-18 12:30pm GMT

Q2 2018 Kaman Corp Earnings Call

BLOOMFIELD Aug 27, 2018 (Thomson StreetEvents) -- Edited Transcript of Kaman Corp earnings conference call or presentation Thursday, August 9, 2018 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James G. Coogan

Kaman Corporation - VP of IR

* Neal J. Keating

Kaman Corporation - Chairman, CEO & President

* Robert Daniel Starr

Kaman Corporation - CFO & Executive VP

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Conference Call Participants

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* Edward James Marshall

Sidoti & Company, LLC - Research Analyst

* Ryan Dale Cieslak

Northcoast Research Partners, LLC - VP & Senior Research Analyst

* Ryan Thomas Mills

KeyBanc Capital Markets Inc., Research Division - Associate

* Seth Michael Seifman

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the second quarter 2018 earnings conference call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Jamie Coogan, Vice President of Investor Relations. Sir, you may begin.

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James G. Coogan, Kaman Corporation - VP of IR [2]

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Good morning. I'd like to welcome everyone to Kaman's Second 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 second 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?

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Neal J. Keating, Kaman Corporation - Chairman, CEO & President [3]

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Thank you, Jamie. Good morning, and thank you for joining us. I'll begin today with a brief overview of our segments before I pass the call over to Rob for a closer look at the numbers.

Beginning with Aerospace, segment sales were up 4.9% as we saw increased volume for our Specialty Bearings products and legacy missile fuze programs combined with continued JPF growth as we perform an Option 13 of our U.S. government contract. The segment margin decline in the quarter was largely expected based on the mix of business and the restructuring and severance costs we incurred in the period. In the second half, we expect this mix to improve as we recognize additional JPF revenue, see a ramp in sales in our Specialty Bearing products and realize the benefits from our restructuring actions.

Backlog at quarter-end grew to $825 million, up 34% from year-end. In the second quarter, we secured a number of new awards, including Option 14 with the U.S. government on our JPF program and lot 15 from Bell Helicopter on our AH-1Z program.

During the quarter, we shipped approximately 7,000 fuzes as compared to just over 7,900 fuzes in the prior year, with a majority of these shipments related to our U.S. government orders. Through the second quarter, we've shipped nearly 11,000 fuzes and continue to expect 2018 to be a record year with 34,000 to 38,000 fuzes being delivered to both U.S. government and foreign customers.

Our backlog for this product remains exceptionally strong. And at quarter-end, we had a total backlog of $427.4 million compared to $128.2 million at year-end 2017. In addition to the $69 million USG Option 14 order we announced in the second quarter, we have several additional late-stage opportunities that could add to an already robust backlog.

The balance of our Aerospace business has performed well, specifically, sales for our Specialty Bearings and engineered products increased in the low double-digit range, with contributions from all product categories in the period. Backlog for these products is up 7% since year-end, driven by an increase in orders for our self-lubricating bearings for our regional business jet and military and commercial engine customers as well as a significant increase in new orders for our miniature bearing products.

Over the next 12 to 18 months, there are several platforms that are expected to provide nice growth opportunities for our self-lube bearing products, including the Joint Strike Fighter, the Airbus A220 and A350, which both saw strong demand at the recent Farnborough Airshow, the Bombardier Global 7500 and the Boeing 737 MAX. Beyond these near-term opportunities, we continue to support investments in new product development and look forward to the ramp up in production of the Boeing 777X and Sikorsky CH-53K.

Currently, we expect to complete our SH-2 upgrade program with Peru by the end of 2018, which will return 4 aircraft into service. And we've recently seen encouraging signs on an upgrade program for the SH-2 helicopters with the Egyptian government.

Our K-MAX marketing efforts continue, as the level of interest in the performance and capabilities of the aircraft remains high. And we believe the recently announced aircraft leasing partnership with Rainier Heli International will provide an important channel to market.

On the margin side, we recorded some onetime costs related to employee separation, severance and inventory adjustments, which put pressure on Aerospace profitability in the quarter. We continue to make progress on our restructuring actions and expect the benefits from these actions to start to materialize in the latter half of the year contributing to improved operating profit performance for the segment.

Turning to Distribution. Organic sales increased 3.9% versus the prior year, with backlog increasing 14% since year-end to $144 million, as we continue to see strong order intake for our automation and fluid power products.

Over the course of the quarter, daily sales trends increased sequentially with each of our platforms seeing growth. We ended the quarter on a high note with sales per sales day for the month of June at the highest level since September of 2015, led in part by an approximately 10% increase in fluid power sales for the month when compared to the prior year period. These trends have continued into July where sales at Distribution were up 11.5% or 5.6% on a sales per sales day basis from the prior year.

Operating margin was 4.7%, up 50 basis points from the first quarter, but down 90 basis points from the second quarter of 2017. Our performance in the quarter was negatively impacted by a number of items, including adjustments to our vendor incentives, group health costs and higher freight costs.

In a continuing effort to improve the long-term profitability of the business, we have recently implemented a series of cost reduction measures and organizational realignment actions, designed to increase our direct customer contact and speed decision-making across the organization. We expect these actions will result in approximately $600,000 of expense for the year and provide annual savings of approximately $2.5 million.

Continued strong cash flow in the quarter positions us well to execute on our previously announced acquisition strategy that is focused on expanding the breadth and reach of our Specialty Bearings and engineered product offerings.

At the halfway point in the year, things are shaping up largely as expected at the consolidated level with some adjustments within our segments, as Rob will detail in our guidance.

With record backlog in Aerospace, new National Account wins coming online in Distribution and the implementation of cost savings initiatives at both segments, we are poised to deliver on a strong second half and are very well positioned as we move towards 2019.

Now I'll turn the call over to Rob to take you through the financials and our updated guidance. Rob?

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [4]

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Thank you, Neal, and good morning, everyone. I will begin by touching on our performance for the quarter and finishing with an update to our 2018 outlook.

Consolidated sales in the second quarter increased 4.3% to $468.1 million over the prior year. The adoption of the new revenue standard contributed $18.5 million and favorable foreign currency exchange rates contributed another $2.5 million. Diluted earnings per share of $0.53 included the $2 million of restructuring and severance costs incurred in the quarter as well as a $1.5 million gain on the sale of assets. When adjusted for these items, we achieved adjusted diluted earnings per share of $0.54 compared to $0.48 in the prior year.

Aerospace sales increased 4.9% to $178.6 million compared to $173.0 million in the prior year period. Sales for the quarter included a higher mix of JPF, DCS deliveries and an increase in revenue for USG, JPF and legacy missile fuzes.

Additionally, we saw an increase in Specialty Bearing product sales, primarily related to higher volume for our miniature bearings and PMA offerings, which experienced a 24% increase over the prior year period.

Operating margin for Aerospace was 12.7% or 13.7% when adjusted for the $1.8 million of restructuring and severance expenses. The decrease in operating margin for the quarter was driven in part by lower profit on certain composite and metallic structured programs, offset by increased profit on our missile fuze programs.

At Distribution, our sales increased 3.9% to $289.5 million compared to $278.7 million in the prior year period. Daily sales for the quarter totaled $4.5 million per sales day, a 3.9% increase over the prior year and a 2.0% increase over the first quarter 2018.

Looking at the performance of our product platforms for the period, all 3 platforms contributed to higher sales, with fluid power and bearings and power transmission products up 6.4% and 4.4%, respectively. Operating margin performance of 4.7% was below our expectations as we experienced higher freight expense, adjustments to our vendor incentives and higher-than-anticipated group health costs in the quarter.

In April, we announced $2.4 million in onetime employee incentives and we began to recognize the expense associated with these incentives during the second quarter. Of the amount recorded in the quarter, $800,000 was recognized at Distribution and $400,000 was recognized at Aerospace. We expect the remainder of the expense to be recognized in the third quarter. With the absence of this expense in the fourth quarter providing a sequential benefit to the operating margins of our segments.

Our cash flows from operations improved by $18.5 million over the second quarter of 2017 to $36.8 million. Free cash flow of $27.4 million in the quarter brings our year-to-date free cash flow to $77.9 million, including $20 million of discretionary pension contributions made thus far in 2018. This improvement in cash flow over the prior year has allowed us to reduce our debt-to-capitalization ratio to 33.5% while reducing our debt leverage ratio to 2x.

Moving to our outlook. We are tightening the expected sales range at Aerospace to $755 million to $775 million given the increased visibility we have to the back half of the year.

We now expect operating margins in the range of 15.9% to 16.1%, or 16.6% to 16.8% when adjusted for the approximately $5.5 million of restructuring and transition costs.

The improvement in operating margin in the back half of the year is related to the sales mix, which is weighted towards JPF, DCS and Specialty Bearings sales and the initial benefits from our restructuring actions.

Similar to prior years, we anticipate a significant portion of sales and operating profit at Aerospace to be achieved in the fourth quarter, specifically related to our JPF program.

At Distribution, we are increasing our sales range to $1.135 billion to $1.17 billion due to the organic sales growth we achieved in the first half of the year and the completion of a significant portion of our National Account onboarding processes during the second quarter. This implied organic growth for the year of 5% to 8% is up from the 3% to 7% implied under our previous outlook.

We are reducing our expectations for operating margin for the year due to a shift in sales mix, the cost of the restructuring activities and the continuation of the higher-than-anticipated costs we experienced in the second quarter. We now expect operating margins in the range of 4.8% to 5.0%, or 4.9% to 5.1% when adjusted for the $600,000 of restructuring and severance costs in the year.

The benefit we expect from these restructuring actions, as well as the expected increase we anticipate in sales and resulting leverage gain from this increase, provide us confidence in the implied operating margin outlook in the back half of the year.

Our expectations for corporate expense have increased by $1 million to $60 million for the year due to anticipated continuation of increased group health costs, while our tax rate for the year is now expected to be 24.5% due to the discrete benefit we received from the $10 million discretionary pension contribution we made in April. We are also making a slight revision to our expected weighted average diluted shares outstanding from 28.0 million to 28.2 million.

Moving to the cadence of earnings for the year. We expect approximately 65% of our earnings in the second half of the year with approximately 50% of our full year earnings in the fourth quarter.

Finally, we are evaluating the benefits of an additional discretionary pension contribution in the third quarter of 2018. If we were to make this contribution, we would receive a discrete tax benefit similar to the one received in the second quarter, which would further reduce our effective tax rate for the year. The impact of this additional pension contribution has not been included in our expectations for our effective tax rate and cash flow forecasts for the year.

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

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Neal J. Keating, Kaman Corporation - Chairman, CEO & President [5]

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Thanks, Rob. Finally, before turning the call over to Jamie, I wanted to take a moment to thank our K-MAX operators and all of the Kaman employees supporting their efforts fighting the fires that continue to burn in the Western United States. We currently have more than half of our fleet of 26 aircraft actively fighting fires in some of the most difficult conditions you can imagine. Their efforts are helping to make a difference out West, and we want to make sure to recognize their extraordinary contribution.

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

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James G. Coogan, Kaman Corporation - VP of IR [6]

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Operator, may we have the first question, please?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Edward Marshall of Sidoti & Company.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [2]

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Listen, I wanted -- Rob, I think in your comments, I think I heard you say that $18.5 million to the accounting change and $2 million for FX. Does that mean that organic sales was down? How do we think about that with the accounting changes?

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [3]

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Yes. So a good question. So yes, if you were to look at the increase in growth, net of the impact of the revenue standards then sales will be roughly flat year-over-year, certainly, and also, we had a benefit to FX. Now keep in mind the FX benefit -- I mean, we do have rates that we forecast. So we weren't really surprised to see the FX impact, so that was kind of built into our outlook.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [4]

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Got it. And so if I think about Aerospace, I'm assuming that's where you're seeing the bulk of its impact.

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [5]

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That's correct.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [6]

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Yes. And so when I think about defense funding, a lot of companies we follow are saying that they're an easier route on the budget. But I'm not sure you're seeing the same thing. Is that happening?

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [7]

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I'm sorry, are you talking about pension funding relating to...

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [8]

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No, I'm talking about defense funding and the flow of defense spending. I'm wondering where -- is it on the commercial or is it on the defense side?

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [9]

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No. I mean, I think really we're seeing good growth on both sides on the commercial and military side on the defense side. So in terms of -- what we're seeing is a very supportive overall defense environment and certainly, a number of our contracts, whether it be JPF to UH-60 and so forth, we're feeling very comfortable in our outlook based on what's in the budget. So I'm not sure I'm 100% following your...

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [10]

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If I take a look at the 2 businesses and I ex out and I look at the organic sales growth on the top line, I'm assuming the majority of that lands within Aerospace. And so as I step back and I think about maybe where -- what's happening there to give you kind of a flattish organic growth rate in the combined businesses. I'm just trying to understand where -- what business lines that may be developing? Is it just timing that you're seeing this kind of delay there? I'm just trying to get hands around that.

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [11]

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Yes. So Ed, in terms of looking at the, let's call it, flat organic growth, I mean, we're clearly seeing positive in Distribution. On the Aerospace side, on ASC 605 basis, the old standard, a certain of our structures programs would be registering lower sales year-over-year because we haven't delivered. So really what you're seeing is more around timing. And as we touched on in our year-end call, net-net, we expect to see about a $15 million to $25 million benefit for the full year relating to revenue standard. Year-to-date, we've seen $62 million. So we expect that to unwind in the balance of the year. So organically, we feel very comfortable that we're seeing decent levels of growth in our aerospace platforms and there's really a negligible impact to the standard overall to Distribution. So this is more around timing, Ed.

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Edward James Marshall, Sidoti & Company, LLC - Research Analyst [12]

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I got it. That makes sense. Okay. And if I think about the Distribution side of the business, it's where I think you might find inflation creep in. I think it passes through on the other side of the business. Are you seeing any inflation in particular? I note that you've already talked about freight.

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Neal J. Keating, Kaman Corporation - Chairman, CEO & President [13]

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Ed, it's Neal. In addition to freight, we are beginning to see some of the price increases come through from our suppliers, predominantly around the July 1 time frame. So if we think about price inflation in the second half of the year, I think it's consistent with what we said in our last quarter call as to what we would anticipate in about the 1% to 1.5% range for the year. But almost all of that impact coming in the second half of the year.

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Operator [14]

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Our next question comes from Ryan Cieslak of Northcoast Research.

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Ryan Dale Cieslak, Northcoast Research Partners, LLC - VP & Senior Research Analyst [15]

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Just really quick a point of clarification. Rob, if I heard you right, you said the cadence of earnings about 50% in the fourth quarter, which would imply obviously then 10% in the third quarter. So are you saying that earnings will be down roughly 50% year-over-year in the third quarter? I just want to make sure that I'm understanding that certainly considering consensus is way ahead of that.

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [16]

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Yes, no. So Ryan, just a couple of things. We're not expecting to see that dramatic of a decline. So if you take a look at where we are this year relative to where we were last year, we're in roughly a similar position, with roughly a little more than 1/3 of our expected earnings already in the first half of this year and we're in a similar position. We're expecting of the remaining, call it, 2/3, put rough math about 50% of that to fall in the fourth quarter. So roughly, let's call it somewhere between 17%, 18%, somewhere in that range to fall in the third quarter of our full year estimate.

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Ryan Dale Cieslak, Northcoast Research Partners, LLC - VP & Senior Research Analyst [17]

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Okay. So if I look at, though, historically, you never had that much of a weight in the fourth quarter on a full year basis. Just what's driving that this year. I just want to make sure I understand that?

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [18]

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There are really 2 primary factors driving this, and it is more accentuated than in years past. So you're absolutely correct. And it certainly that way we would draw up, so to say, but it's really being responsive to the customer demand. So there's really 2 factors: one is a very significant ramp-up in our bearing sales and operating margin in the fourth quarter; and then also the timing of JPF, DCS deliveries that are built into our forecast. Those are the 2 largest drivers that we expect to see. And obviously, there is a continuation in improvement in Distribution as well that's contributing as well.

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Neal J. Keating, Kaman Corporation - Chairman, CEO & President [19]

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And Ryan, if I could just add on there. As we've experienced good growth in our Specialty Bearings product lines, and we have this phenomena of very strong fourth quarter growth, just the numbers get larger too. So it impacts our profitability even more so since that business is growing.

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Ryan Dale Cieslak, Northcoast Research Partners, LLC - VP & Senior Research Analyst [20]

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Okay. That's helpful. So I wanted to go to Distribution because that, I think, was where the results were a little bit weaker than I was looking for and certainly, the outlook looks like it is coming down on the margin side. And you guys announced some restructuring there. What's different ultimately about the new restructuring that you're talking about and some of the initiatives now that are focused on the margin side relative to what it seemed to be some actions taken in the last year or so? If I remember, Neal, that really sort of helped your margin trends. It seems like we're bumping up against some additional issues. I just want to make sure I understand what's different that you're doing today versus some of the things you guys implemented back in '16 and '17?

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Neal J. Keating, Kaman Corporation - Chairman, CEO & President [21]

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Ryan, it's actually in this case very different. What I -- how I would characterize, it is more of a natural progression as we've looked at various areas that we think we can improve the performance of the business. You're exactly right. We spent a significant amount of time, effort and resources behind some productivity initiatives, and quite frankly, we felt very good about the results that we got from that. And now we think we also have a very good balance between organic growth and profitability. As we looked at the organization, we actually went through a consolidation. We used to have 5 regions across the United States. We've moved to 4. It enabled us to focus more, more people on the front line with customers and remove some actually administrative redundancy and hopefully as well speed some decision-making in the organization. So it really was one where we looked at the organization. We felt that it would work in our best interest and our customers' best interest to move from 5 regions to 4 and actually the gentleman that was heading up one of those regions has now taken -- Tom Holtry has taken responsibility for our National Accounts organization, and we feel that's one of the reasons that we're seeing some of the improvement there. So I would characterize it more as a natural progression as any business goes through time, they see areas where they can continue to change and improve efficiencies, and that's what we did in this quarter.

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [22]

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Ryan, if I may. I just want to take a step back and use your question as an opportunity to talk about the margin. For the quarter, Distribution out at 4.7%, but if you were to really adjust for the 2 items, the vendor rebate impact as well as the employee incentive, that gets us pretty close to the implied margin range that we expect to deliver in that business for the back half of the year. And if you were to look at our operating margin outlook, it's pretty much adjusted for the impact of the group health impact as well as the vendor rebate. I mean, everything else has pretty much stayed the same at Distribution in terms of the underlying performance. And when we look at the full year, excluding the impact of pension accounting on a like-for-like basis, we really are seeing nearly almost a 20% OI growth year-over-year in Distribution. So we feel really good about the business. It's been great having Al lead the business with his team and they're making a lot of very positive changes there. So I just want to kind of lay that out that while we did take the outlook down, there are some discrete reasons why we've done that, but the underlying performance of the business remains very much intact.

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Ryan Dale Cieslak, Northcoast Research Partners, LLC - VP & Senior Research Analyst [23]

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Okay. That's helpful, Rob. Clearly -- it isn't clear when you just look at the results at a high level. But just to maybe to follow up on that point, the implied guidance that you have now in the back half assumes Distribution margins. I'm getting, I think, up roughly 100 basis points sequentially and I get maybe some benefit from the restructuring, and certainly, it sounds like some of the incentive comp rolls off in the fourth quarter. I think margins are typically down sequentially for you guys. So if you just had to maybe put it in buckets, what are the major drivers to get you to see that margin improvement sequentially in Distribution, considering, I think, the national sales that are coming through should be lower margin just from a mix standpoint, and maybe just correct me if I'm wrong there, but any help there would be great?

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Neal J. Keating, Kaman Corporation - Chairman, CEO & President [24]

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Sure. I'll start, Ryan. I think that as Rob just said, if you look at our results for the second quarter and were to adjust it for the onetime events of both the employee incentive as well as the vendor rebates, we're about at the mid-range of the outlook in profitability for the second half of the year. And so: a, that gives us a good baseline that we can get there. In addition, we are anticipating continued growth at the midpoint about up 3.5% from the first half run rate. We will certainly get additional operating leverage from that organic growth. Normally, you are exactly right, our fourth quarter tends to fade a little bit, and we're not anticipating that this year simply because of the continued organic growth from the National Accounts that will be added. And while national accounts typically come in at slightly lower margins, it certainly does help us on the vendor incentive side. So we won't be in a position in the second quarter of next year as we were this year with a negative adjustment.

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Ryan Dale Cieslak, Northcoast Research Partners, LLC - VP & Senior Research Analyst [25]

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Okay. That's helpful. And the last one from me and then I'll hop back in the queue. With the restructuring going on now at Distribution, do you think differently about the implementation of the ERP? I think you guys were targeting maybe starting to restart that in the back half. And then also, though, Neal, how much of maybe the progression in segment margins at Distribution is ultimately do you think going to be tied to you guys being able to get that new ERP implemented and helping you guys out obviously just from a cost and efficiency standpoint going forward?

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Neal J. Keating, Kaman Corporation - Chairman, CEO & President [26]

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Ryan, we really haven't changed our schedule very much. We'll be doing our next significant ERP upgrade in the third quarter of this year. And we've had very good results from the system as we've gone through the testing of this new upgrade. So we feel very good about that. I think that we will clearly get some efficiencies from it. That's why we're doing it, but I think we'll see it as well in our inventory management, it's going to provide us a significant improvement in our purchasing tools over what we have today. So I think that in working capital management, it will help us significantly, and clearly, we have multiple ERP systems in place today, and our ability to reduce those over time to one will certainly add some efficiencies. But we are going full speed ahead with our next upgrade in the third quarter.

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Operator [27]

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(Operator Instructions) Our next question comes from Steve Barger of KeyBanc Capital.

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Ryan Thomas Mills, KeyBanc Capital Markets Inc., Research Division - Associate [28]

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This is Ryan on for Steve. In your updated growth guidance in Distribution, do you have like expected growth rate for new and existing National Accounts versus smaller customers?

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [29]

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Yes. Ryan, we've never given explicit guidance on that, but what I can tell you is, the growth that we expect for National Accounts is, it's certainly the largest contributor to the back half of the year growth. I mean, we are expecting to see growth across all of our customer segments, but certainly National Accounts is really, as we've talked about for some time, is where we're going to see the majority of it.

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Ryan Thomas Mills, KeyBanc Capital Markets Inc., Research Division - Associate [30]

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And have you guys provided what's the mix of that between national and small?

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [31]

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No. We have not. But certainly, that mix will change a little bit just given relative growth rates. We would expect National Accounts to be going forward a bit more of the mix.

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Ryan Thomas Mills, KeyBanc Capital Markets Inc., Research Division - Associate [32]

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Okay. And then my last question looking at the balance sheet, inventory has been the source of cash here for a couple of quarters. Just thinking right now with the expected growth rates you have in the back half, do you feel comfortable with your inventory levels right now? Do you still have room to maybe deplete those out a little bit more?

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [33]

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Yes. I would say on the Aerospace side, it's going to come down to shipments -- timing of shipments, but based on the forecast, I think the answer is, yes, I think we have some room yet still to take down some inventory levels. There is always room for improvement, Ryan.

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Operator [34]

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Our next question comes from Seth Seifman of JPMorgan.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [35]

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I was wondering about Distribution and if you could talk a little bit about from a -- in terms of maybe disentangling a little bit the growth that we're going to see in the second half and probably into the first half of next year relative to, let's say, a normal growth rate. I guess, there is a share gain (technical difficulty) of small accounts getting onboarded and then once they're onboard, they'll still be growing, but they will have been added into the base. And so kind of in thinking about maybe how the market is -- the underlying market is growing sort of organically in the second half versus the growth that we're going to see, is there kind of a back-of-the-envelope way to think about that differential?

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Neal J. Keating, Kaman Corporation - Chairman, CEO & President [36]

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It's a good question. And I think we'll think about it a little bit more. But clearly, we're seeing growth both across our -- the traditional manufacturing base, Seth, in what we would call the MRO part of our business. And we've actually in the first half of the year seen a more significant uptick in our OEM business. So it means that industry is investing capital at a little bit higher rate, I think the macro numbers show that. So I think that we've clearly had underlying market growth with customers that we have done business with for a long time. And then now as we enter into the second half of this year, there will be some share shift, specifically related to the national accounts because those change hands occasionally, whether it is to command or from command to one of our competitors. We've been a little bit more successful in the last 6 months than we had been in the prior couple of years really based on the breadth of our product offering and the comprehensive nature of services that we can wrap around those products. So we think that we will benefit marginally from some share shift as well. But right now, the underlying industrial economy is pretty good for us, better than it's been for a while and we're happy to be taking advantage of some of that.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [37]

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Great. Okay. And then just maybe one quick follow-up on the numbers, and I apologize if I'm missing the math a little bit. But for the implication is that half of full year EPS will be in the fourth quarter and so Q3, I assume is down from Q2. And if so, is there something specific that's driving the sequential -- is there a sequential decline on the operational side? And if so, what's driving it? Or is it mainly kind of a normalized tax rate? And what are kind of the key drivers as we look from Q2 to Q3?

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [38]

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A couple of things there, Seth. We unfortunately use the word approximate because we don't give specific outlook. But we're not necessarily expecting a downturn in Q3 earnings in terms of EPS. So part of what you're seeing is the tax rate impact. We certainly had a very low effective rate in the quarter, I mean, 18.6% versus a full year rate that we're expecting at 24.5%. So you will see some impact certainly in the out-quarters relating to the tax rate. We'll keep everyone apprised, obviously, if we decide to do another pension contribution because that would impact the rate. But certainly, there are just changes in the mix of timing in a number of our businesses between the third and fourth quarter that are also going to have an impact in terms of just the cadence. I mean, we'll see more earnings in the fourth quarter than what we had seen previously on our last call.

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Neal J. Keating, Kaman Corporation - Chairman, CEO & President [39]

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And that's really driven, Seth, by the increase in shipments and mix that goes towards our higher profit Specialty Bearings product lines, the year-over-year growth in that business and also, as you know, our JPF shipments on a direct commercial sale basis are significantly more profitable than sales to the U.S. government. And currently, our projections anticipate a much higher percentage of those DCS shipments being made in the fourth quarter. So it's really if you were to break it down on the Aerospace side into 3 things, it's going to be higher mix of higher profit Specialty Bearings in the fourth quarter, higher mix of higher profit JPF in the fourth quarter and also, we're beginning to get benefits from the restructuring actions that we began in the third quarter of 2017. So that will flip for us as well. So those 3 factors would really provide the basis for that improvement into the fourth quarter.

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Robert Daniel Starr, Kaman Corporation - CFO & Executive VP [40]

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And just one other point, Seth, I know you're new on the account and I think you have to all keep in mind that given the relative profitability of our bearings and fuzing lines, small timing shifts can move the earnings estimates considerably between quarters. So we're giving you our best look at it.

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Operator [41]

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And I'm showing no further questions in queue at this time. I would like to turn the call back to Jamie Coogan for any closing remarks.

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James G. Coogan, Kaman Corporation - VP of IR [42]

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

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Operator [43]

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

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