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KAMAN CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide readers of our condensed consolidated financial statements with the perspectives of management. It presents, in narrative form, information regarding our financial condition, results of operations, liquidity and certain other factors that may affect our future results, and is designed to enable the readers of this report to obtain a comprehensive understanding of our businesses, strategies, current trends and future prospects. It should be read in conjunction with our 2013 Annual Report on Form 10-K. OVERVIEW OF BUSINESS Kaman Corporation (the "Company") is comprised of two business segments: • The Distribution segment is a leading power transmission, motion control, electrical and automation, and fluid power industrial distributor with operations throughout the United States and Mexico. We provide products including bearings, mechanical and electrical power transmission, fluid power, motion control, automation, material handling components, electrical control and power distribution, and MRO supplies to a broad spectrum of industrial markets throughout the United States and Mexico. • The Aerospace segment produces and/or markets proprietary aircraft bearings and components; complex metallic and composite aerostructures for commercial, military and general aviation fixed and rotary wing aircraft; safe and arming solutions for missile and bomb systems for the U.S. and allied militaries; subcontract helicopter work; support for our SH-2G Super Seasprite maritime helicopters and K-MAX® manned and unmanned medium-to-heavy lift helicopters; and engineering design, analysis and certification services. Financial performance • Net sales from continuing operations increased 9.1% and 7.4% for the three months and nine months ended September 26, 2014, respectively, compared to the comparable periods in the prior year. • Earnings from continuing operations decreased 20.4% and 2.8% for the three months and nine months ended September 26, 2014, respectively, compared to the comparable periods in the prior year. • Diluted earnings per share from continuing operations decreased to $0.53, a decrease of $0.15, or 22.1% for the three months ended September 26, 2014, compared to the comparable period in the prior year. For the nine months ended September 26, 2014, diluted earnings per share from continuing operations decreased to $1.53, a decrease of $0.08, or 5.0% compared to the comparable period in the prior year. • Cash flows provided by operating activities of continuing operations for the nine months ended September 26, 2014, were $43.5 million, $18.6 million more than the comparable period in the prior year. • For the three months ended September 26, 2014,our Distribution segment achieved record net sales of $308.6 million. Significant events • The Company announced that it has been awarded an extension to its current Global Outline Agreement ("GOA") with Bell Helicopters to manufacture skin and skin to core components for a majority of Bell's commercial helicopter models. This three-year follow on contract has an expected value exceeding $24 million. • The Company is currently in negotiations with General Dynamics Canada to remanufacture and upgrade four Kaman SH-2G Super Seasprite aircraft, and will provide support for the operation of a fifth aircraft for the Peruvian Navy. • On October 21, 2014, the Company entered into a civil settlement agreement with the U.S. Attorney's Office for the District of Kansas, associated with a matter at its Wichita facility. • On September 18, 2014, the Company held its first Investor Day in New York City. • On September 12, 2014, the Company announced that its subsidiary, Kaman Aerospace Corporation, sold its former manufacturing facility in Moosup, Connecticut, to TD Development, LLC. • During the third quarter of 2014, the Company settled its revenue sharing agreement with the Commonwealth of Australia for $5.3 million. 24--------------------------------------------------------------------------------Outlook We are lowering our sales range at Distribution to $1,185 million to $1,195 million from $1,190 million to $1,220 million and operating income to 4.5% to 4.6% from 4.8% to 5.2%. At Aerospace, we are lowering our sales range to $630 million to $640 million from $640 million to $660 million; however, we are increasing our range for operating income to 16.8% to 17.0% from 16.5% to 16.7%. Additionally, we are lowering our expectations for Corporate Expense to $51 million from $52 million and our tax rate to 34% from 35%. Finally, we have increased our Free Cash Flow(a) expectations for the year by $5.0 million, to $55 million to $60 million. Our updated outlook for 2014 is as follows: • Distribution: • Sales of $1,185 million to $1,195 million • Operating margins of 4.5% to 4.6% • Aerospace: • Sales of $630 million to $640 million • Operating margins of 16.8% to 17.0% • Interest expense of approximately $13.5 million • Corporate expense of approximately $51 million, excluding $2.3 million of charges related to the sale of the idle facility in Moosup, CT • Estimated annualized tax rate of approximately 34% • Depreciation and amortization expense of approximately $38 million • Capital expenditures of $30 million to $35 million • Free cash flow in the range of $55 million to $60 million The following table illustrates the calculation of "Free Cash Flow", a Non-GAAP financial measure: 2014 Outlook In millions Free Cash Flow(a): Net cash provided by operating activities $ 85.0 to $ 95.0 Expenditures for property, plant and equipment 30.0 to 35.0 Free Cash Flow $ 55.0 to $ 60.0 (a) Free Cash Flow, a non-GAAP financial measure, is defined as net cash provided by operating activities less expenditures for property, plant and equipment, both of which are presented on our consolidated statements of cash flows. See Management's Discussion and Analysis of Financial Condition and Results of Operations-Non-GAAP Financial Measures. RESULTS OF OPERATIONS Consolidated Results Net Sales For the Three Months Ended For the Nine Months Ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 (in thousands) Net sales $ 462,332 $ 423,663 $ 1,335,353 $ 1,243,463 $ change 38,669 14,096 91,890 49,951 % change 9.1 % 3.4 % 7.4 % 4.2 % 25--------------------------------------------------------------------------------The following table details the components of the increase in net sales as a percentage of consolidated net sales: For the Three Months Ended For the Nine Months Ended September 26, 2014 September 26, 2014 Organic Sales(1): Distribution 1.1 % 1.1 % Aerospace 0.7 % 1.2 % Total Organic Sales 1.8 % 2.3 % Sales by Recent Acquisitions: Distribution 7.3 % 5.1 % Aerospace - % - % Total Acquisition Sales 7.3 % 5.1 % % change in net sales 9.1 % 7.4 % (1) Sales contributed by acquisitions are included in organic sales beginning with the thirteenth month following the date of acquisition. See segment discussions below for additional information regarding the changes in net sales. Gross Profit For the Three Months Ended For the Nine Months Ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 (in thousands) Gross profit $ 129,505 $ 118,857 $ 373,700 $ 350,380 $ change 10,648 4,788 23,320 17,879 % change 9.0 % 4.2 % 6.7 % 5.4 % % of net sales 28.0 % 28.1 % 28.0 % 28.2 % The increase in gross profit for the three months and nine months ended September 26, 2014, as compared to the same periods in 2013 is attributable to the higher gross profit at our Distribution segment. The increase at Distribution was due to higher organic gross profit, which increased 2.2% and 2.0% for the three months and nine months ended September 26, 2014, respectively, and the contribution of gross profit recorded by the 2013 and 2014 Distribution segment acquisitions. Partially offsetting the higher gross profit at our Distribution segment for the nine months ended September 26, 2014, was a decrease in gross profit at our Aerospace segment, primarily related to the sales mix of our bearing products, lower gross profit under our JPF program due to lower commercial sales to foreign governments, a decrease in sales of our engineering design services and lower margins on our tooling product sales. These decreases were partially offset by the gross profit associated with New Zealand SH-2G(I) program sales. Selling, General & Administrative Expenses (SG&A) For the Three Months Ended For the Nine Months Ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 (in thousands) SG&A $ 103,502 $ 87,436 $ 298,853 $ 274,075 $ change 16,066 (1,717 ) 24,778 11,192 % change 18.4 % (1.9 )% 9.0 % 4.3 % % of net sales 22.4 % 20.6 % 22.4 % 22.0 % 26--------------------------------------------------------------------------------SG&A increased by 18.4% and 9.0% for the three months and nine months ended September 26, 2014, respectively, as compared to the corresponding 2013 periods. The following table details the components of the change: For the Three Months Ended For the Nine Months Ended September 26, 2014 September 26, 2014 Organic SG&A(1): Distribution 6.5 % 1.5 % Aerospace 0.3 % 0.1 % Corporate 3.4 % 2.2 % Total Organic SG&A 10.2 % 3.8 % Acquisition SG&A: Distribution 8.2 % 5.2 % Aerospace - % - % Total Acquisition SG&A 8.2 % 5.2 % % change in SG&A 18.4 % 9.0 % (1)SG&A expense incurred by acquisitions are included in organic SG&A beginning with the thirteenth month following the date of acquisition. The increase in SG&A for the three-month period ended September 26, 2014, was primarily attributable to higher expenses at our Distribution segment due to the 2013 and 2014 Distribution segment acquisitions, higher employee related incentive costs, higher salary and wage expense primarily associated with the expansion of our sales force and higher depreciation related to the new enterprise-wide business system ("ERP"). Additionally, corporate expenses were $3.0 million higher for the three-month period ended September 26, 2014, primarily driven by $2.3 million of costs incurred in connection with the sale of our Moosup facility. The increase in SG&A for the nine-month period ended September 26, 2014, was primarily attributable to higher expenses at our Distribution segment due to the 2013 and 2014 acquisitions. Additionally, our corporate expenses were up by $6.1 million driven by costs related to the sale of our Moosup facility, higher incentive compensation costs and an increase in depreciation expense associated with building renovations. Operating Income For the Three Months Ended For the Nine Months Ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 (in thousands) Operating income $ 25,956 $ 31,421 $ 74,632 $ 76,205 $ change (5,465 ) 6,558 (1,573 ) 6,608 % change (17.4 )% 26.4 % (2.1 )% 9.5 % % of net sales 5.6 % 7.4 % 5.6 % 6.1 % The decrease in operating income for the three months ended September 26, 2014, versus the comparable period in 2013 was due to the increase in corporate expense discussed above and a decrease in operating income at both our Aerospace segment and Distribution segment. (See segment discussion below for additional information.) The decrease in operating income for the nine months ended September 26, 2014, versus the comparable period in 2013 was due to the increase in corporate expenses discussed above and a decrease in operating income at our Aerospace segment, partially offset by an increase in operating income at our Distribution segment. The increase in operating income at our Distribution segment included the contribution of operating income from our 2013 and 2014 acquisitions. (See segment discussion below for additional information.) 27 --------------------------------------------------------------------------------Interest Expense, Net For the Three Months Ended For the Nine Months Ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 (in thousands) Interest expense, net $ 3,444 $ 3,113 $ 10,060 $ 9,344 Interest expense, net, generally consists of interest charged on our Credit Agreement (see "Liquidity and Capital Resources - Financing Arrangements", below), which includes a revolving credit facility and a term loan facility, and other borrowings and the amortization of debt issuance costs, offset by interest income. The increase in interest expense, net for the three-month and nine-month periods ended September 26, 2014, was primarily attributable to the higher average borrowings, as compared to the same periods ended September 27, 2013. (See Liquidity and Capital Resources section below for information on our borrowings.) Effective Income Tax Rate For the Three Months Ended For the Nine Months Ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 Effective income tax rate 33.2 % 34.0 % 33.6 % 34.2 % The effective income tax rate represents the combined federal, state and foreign tax effects attributable to pretax earnings for the year. The decrease in the effective tax rate for the three-month and nine-month periods ended September 26, 2014, as compared to the rates for the same periods in the prior year was primarily due to a return to provision adjustment recorded during the third quarter. Changes in Condensed Consolidated Balance Sheets Due to the acquisition of the operating assets of B.W. Rogers in the second quarter of 2014, certain line items on our Condensed Consolidated Balance Sheets increased as of September 26, 2014, as compared to December 31, 2013. Specifically, Accounts Receivable, net, Goodwill and Long-term debt, excluding current portion were impacted by this acquisition. In order to fund this acquisition, the Company used borrowings under the Revolving Credit Agreement, increasing the total borrowings under this agreement. See Note 4, Acquisitions for further detail of assets acquired and liabilities assumed as part of the acquisition. In addition to the acquisition of B.W. Rogers, Accounts Receivable, net also increased from December 31, 2013, due to an increase in unbilled costs and accrued profit on certain Aerospace commercial contracts. Other Matters We experienced net losses at one of our foreign operations during the third quarter of 2014. Deferred tax assets associated with net operating losses for this foreign operation is $2.2 million as of September 26, 2014. No valuation allowances have been recorded against these deferred tax assets because the Company believes that these deferred tax assets will, more likely than not, be realized. The determination is based upon the operation's earnings history and its anticipated future taxable income. We will continue to assess the likelihood of the operation's ability to generate future taxable income in order to realize the related deferred tax assets. 28 --------------------------------------------------------------------------------Distribution Segment Results of Operations For the Three Months Ended For the Nine Months Ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 (in thousands) Net sales $ 308,571 $ 272,951 $ 877,627 $ 800,352 $ change 35,620 14,669 77,275 36,573 % change 13.0 % 5.7 % 9.7 % 4.8 % Operating income $ 13,272 $ 14,675 $ 39,826 $ 32,974 $ change (1,403 ) 1,750 6,852 (6,431 ) % change (9.6 )% 13.5 % 20.8 % (16.3 )% % of net sales 4.3 % 5.4 % 4.5 % 4.1 % Net sales The increase in net sales for the three months and nine months ended September 26, 2014, as compared to the same periods in 2013 was primarily driven by the contribution of sales from our 2013 and 2014 acquisitions which totaled $31.1 million and $63.6 million in each of those periods, respectively. Organic sales per sales day is a metric management uses to evaluate performance trends at our Distribution segment and is calculated by taking organic sales divided by the number of sales days in the period. The following table illustrates the calculation of organic sales per sales day. (See Management's Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures.) For the Three Months Ended For the Nine Months Ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 (in thousands) Current period Net sales $ 308,571 $ 272,951 $ 877,627 $ 800,352 Acquisition sales (1) 31,069 17,785 63,605 66,158 Organic sales $ 277,502 $ 255,166 $ 814,022 $ 734,194 Sales days 63 63 189 190 Organic sales per sales day for the current period a $ 4,405 $ 4,050 $ 4,307 $ 3,864 Prior period Net sales from the prior year $ 272,951 $ 258,282 $ 800,352 $ 763,779 Sales days from the prior year 63 63 190 191 Organic sales per sales day from the prior year b $ 4,333 $ 4,100 $ 4,212 $ 3,999 % change in organic sales per sales day (a-b)÷b 1.7 % (1.2 )% 2.3 % (3.4 )% (1) Sales contributed by an acquisition are included in organic sales beginning with the thirteenth month following the date of acquisition. Prior period information is adjusted to reflect acquisition sales for that period as organic sales when calculating organic sales per sales day. 29 -------------------------------------------------------------------------------- Organic sales per sales day for the three months and nine months ended September 26, 2014, increased 1.7% and 2.3%, respectively, as compared to the same periods in 2013. The increase in organic sales per sales day for the three months ended September 26, 2014, as compared to the corresponding prior year period was primarily driven by increases in sales volume to original equipment manufacturer customers and maintenance, repair and operations customers. We experienced higher sales in the transportation equipment manufacturing, machinery manufacturing and paper manufacturing markets. These increases were partially offset by declines in the nonmetallic mineral product manufacturing market. The increase in organic sales per sales day for the nine months ended September 26, 2014, as compared to the corresponding prior year period was primarily driven by increases in sales volume to both maintenance, repair and operations customers and original equipment manufacturer customers. We experienced higher sales for the nine-month period ended September 26, 2014, in the computer and electronic product manufacturing, mining industry and machinery manufacturing markets. These increases were mostly offset by declines in the merchant wholesalers and durable goods market and the nonmetallic mineral product manufacturing markets. Operating income The decrease in Distribution segment operating income for the three months ended September 26, 2014, as compared to the corresponding period in the prior year was driven by higher operating expenses. These expenses include the net cost associated with our sales force expansion, higher employee related incentive costs, severance costs primarily related to the consolidation of back office functions and costs related to our new ERP system. The ERP costs include our first full quarter of depreciation expense. These increases were partially offset by the addition of operating income from 2013 and 2014 acquisitions. The increase in Distribution segment operating income for the nine months ended September 26, 2014, as compared to the corresponding prior year period, was driven by the contribution of operating income from our 2013 and 2014 acquisitions and higher organic sales and corresponding profit. Partially offsetting these increases are higher SG&A expenses that include net costs associated with the expansion of our sales force, continued headwinds from our Mexico operations and the ERP related costs noted above. Other Matters Enterprise Resource Planning System In July 2012, we announced our decision to invest in a new enterprise-wide business system for our Distribution segment. The anticipated total investment in the new system is approximately $45 million, which will be incurred over a number of years. Of the total investment, we expect that approximately 75% will be capitalized. From its inception through September 26, 2014, we have spent $28.3 million on this project, of which $25.0 million has been capitalized. Depreciation and amortization of the capitalized cost commenced in July 2014 and is expected to increase over the next three to four years. In order to minimize disruptions to our ongoing operations we have developed a project plan that takes a phased approach to implementation and includes appropriate contingencies. In early July 2014, the Distribution segment reached a significant milestone when the Minarik Automation & Controls facilities went live on the new system. For the three months and nine months ended September 26, 2014, expenses incurred totaled approximately $0.2 million and $0.7 million, respectively, and capital expenditures totaled $1.5 million and $7.3 million, respectively. 30--------------------------------------------------------------------------------Aerospace Segment Results of Operations For the Three Months Ended For the Nine Months Ended September 26, September 27, September 26, September 27, 2014 2013 2014 2013 (in thousands) Net sales $ 153,761 $ 150,712 $ 457,726 $ 443,111 $ change 3,049 (573 ) 14,615 13,378 % change 2.0 % (0.4 )% 3.3 % 3.1 % Operating income $ 26,813 $ 27,638 $ 75,515 $ 77,227 $ change (825 ) 3,228 (1,712 ) 10,758 % change (3.0 )% 13.2 % (2.2 )% 16.2 % % of net sales 17.4 % 18.3 % 16.5 % 17.4 % Net sales Sales increased for the three-month period ended September 26, 2014, as compared to the comparable period in 2013, primarily due to a $5.1 million increase in sales of our military products/programs. Military sales increases of $27.6 million were primarily attributable to higher shipments of our JPF to the USG, sales under our SH-2G(I) contract with New Zealand and the delivery of three cabins under our AH-1Z program during the quarter. These increases were partially offset by a $21.2 million decrease in military sales resulting from lower direct sales of the JPF to foreign militaries, fewer shipments on the Sikorsky BLACK HAWK helicopter program and lower sales volume on the Egypt SH-2G(E) upgrade program. Offsetting the increase in sales of our military products/programs for the three months ended September 26, 2014, was a $2.0 million decrease in commercial sales. The decrease is primarily the result of lower sales of engineering design services and lower sales volume under the Learjet 85 program as a result of the stop-work order received during the third quarter of 2014, as discussed below in Major Programs/Product Lines - Learjet 85. Sales increased for the nine-month period ended September 26, 2014, as compared to the comparable period in 2013, due to increases of $11.6 million and $3.0 million in sales of our military and commercial products/programs, respectively. Military sales increases of $58.2 million are primarily related to work performed on our SH-2G(I) contract with New Zealand, higher shipments of our JPF to the USG and the delivery of four cabins under our AH-1Z program during 2014. These military sales increases were partially offset by $47.7 million of decreases attributable to lower direct sales of the JPF to foreign militaries, lower military bearing product sales as anticipated due to non-recurring military retrofit orders benefiting the corresponding period last year, fewer shipments on the Sikorsky BLACK HAWK helicopter program and lower sales volume on the Egypt SH-2G(E) upgrade program. Commercial sales increases of $11.0 million reflect increased deliveries on commercial composite structures products/programs and higher commercial bearing product sales. These increases were partially offset by lower sales of engineering design services, a decline in sales volume of composite imaging products and lower sales on the Boeing 767 program, totaling $7.5 million. Operating income The decrease in operating income for the three months ended September 26, 2014, compared to the comparable period in 2013 was primarily due to lower direct sales of the JPF to foreign militaries and lower sales volume under the Egypt SH-2G(E) upgrade program. These products/program profit decreases resulted in $6.0 million of lower gross profit which was partially offset by $4.5 million of higher gross profit for work performed on our New Zealand SH-2G(I) program and higher shipments of our JPF to the USG. 31 -------------------------------------------------------------------------------- The decrease in operating income for the nine months ended September 26, 2014, compared to the comparable period in 2013 was primarily due to lower margins on our military bearing products, lower direct sales of the JPF to foreign militaries, lower margins on our tooling sales and lower gross profit associated with lower sales on the Egypt SH-2G(E) upgrade program. These decreases, totaling $15.5 million, were partially offset by an increase of $13.5 million mostly attributable to the New Zealand SH-2G(I) program, a higher level of sales to the USG under the JPF program and higher sales of K-MAX® spares. Long-Term Contracts For long-term aerospace contracts, we generally recognize sales and income based on the percentage-of-completion method of accounting, which allows for recognition of revenue as work on a contract progresses. We recognize sales and profit based on either (1) the cost-to-cost method, in which sales and profit are recorded based upon the ratio of costs incurred to estimated total costs to complete the contract, or (2) the units-of-delivery method, in which sales are recognized as deliveries are made and cost of sales is computed on the basis of the estimated ratio of total cost to total sales. Revenue and cost estimates for all significant long-term contracts for which revenue is recognized using the percentage-of-completion method of accounting are reviewed and reassessed quarterly. Based upon these reviews, the Company records the effects of adjustments in profit estimates each period. If at any time the Company determines that in the case of a particular contract total costs will exceed total contract revenue, the Company will record a provision for the entire anticipated contract loss at that time. There were net increases to the Company's operating income from changes in contract estimates of $1.3 million and $1.5 million, respectively, for the three-month and nine-month periods ended September 26, 2014. These increases were primarily a result of improved performance on the New Zealand SH-2G(I) program, the Joint Programmable Fuze ("JPF") program and a mix of other legacy fuze and composite programs. These improvements were slightly offset by cost growth on the Sikorsky BLACK HAWK helicopter program and Boeing A-10 program. There were net decreases to the Company's operating income from changes in contract estimates of $0.1 million and $2.8 million for the three-month and nine-month periods ended September 27, 2013. These decreases were a result of cost growth due to revised estimates for various programs, including the Sikorsky BLACK HAWK helicopter program, Bell helicopter offload program and a fuze program. Backlog September 26, December 31, 2014 2013 (in thousands) Backlog $ 527,813 $ 601,954 Backlog decreased during the first nine months of 2014. This decrease is primarily due to work performed on the SH-2G(I) New Zealand program and deliveries of BLACK HAWK helicopter cockpits. Major Programs/Product Lines Below is a discussion of significant changes in the Aerospace segment's major programs during the first nine months of 2014. See our 2013 Annual Report on Form 10-K for a complete discussion of our Aerospace segment's programs. A-10 The segment has contracted with Boeing to produce the wing control surfaces (inboard and outboard flaps, slats and deceleron assemblies) for the U.S. Air Force's A-10 fleet. This contract has a potential value of over $110.0 million; however, annual quantities will vary, as they are dependent upon the orders Boeing receives from the U.S. Air Force. Through September 26, 2014, 93 shipsets have been delivered over the life of this program and we expect to deliver approximately 11 shipsets during the remainder of 2014. The Department of Defense Fiscal Year 2015 Budget has eliminated funding for the A-10 fleet; however, a final determination as to the future of this program has not been made and there is congressional support for its continuation. We received an order for additional shipsets in January 2014, and through the date of this filing we have not received any indication from our customer that this program will be terminated. Tooling and non-recurring costs on this program are being amortized over 242 shipsets, the number of shipsets expected to be delivered under this program. At September 26, 2014, our program backlog was $35.6 million and total program inventory was $18.9 million, of which a significant portion may not be recoverable in the event of a contract termination. 32 --------------------------------------------------------------------------------BLACK HAWK The Sikorsky BLACK HAWK helicopter cockpit program involves the manufacture of cockpits including the installation of all wiring harnesses, hydraulic assemblies, control pedals and sticks, seat tracks, pneumatic lines, and the composite structure that holds the windscreen for most models of the BLACK HAWK helicopter. As a result of lower customer demand, we expect to deliver 90 BLACK HAWK cockpits this year, compared to 114 cockpits delivered in 2013. We currently have $59.3 million of orders under this program in backlog and have delivered 65 cockpits during the first nine months of 2014. AH-1Z The segment manufactures cabins for the increased capability AH-1Z attack helicopter, which is produced by Bell Helicopter ("Bell") for the U.S. Marine Corps. The cabin is the largest and most complex airframe structure utilized in the final assembly of the AH-1Z helicopter and has not been manufactured new since 1995. During the first quarter of 2014, Bell conducted the first test flight for the re-designed AH-1Z helicopter. We have provided Bell with substantially complete cabins to allow Bell to progress on the completion of initial aircraft; however, technical issues preclude us from completing the cabins prior to making delivery. Revenue for this program is recognized based upon customer acceptance of delivered cabins. As of September 26, 2014, we have recognized revenue on a total of five cabins. Our total program inventory is $36.9 million and we currently have $19.0 million in backlog associated with this program; with potential follow-on options the program value could exceed $200.0 million. We continue to work with Bell to resolve the technical issues precluding us from completing the cabins. C-17 The segment produces structural wing subassemblies for the Boeing C-17. During the first quarter of 2014, Boeing announced that it was ending production three months earlier than it had originally planned, resulting in the production of three fewer aircraft. During the first nine months of 2014, we completed deliveries of the final seven shipsets and do not expect to receive any additional orders. FMU-152 - Joint Programmable Fuze ("JPF") The segment manufactures the JPF, an electro-mechanical bomb safe and arming device, which allows the settings of a weapon to be programmed in flight. In July 2014, we were awarded an additional $13.9 million under Option 11 of our contract with the US Government, bringing the total award under this option to $55.8 million, for fuzes to be delivered in 2015 and 2016. Additionally, we were awarded orders totaling $10.8 million by foreign military customers for fuzes to be delivered in 2014. Total JPF backlog at September 26, 2014, is $106.2 million. During the quarter we delivered a total of 6,400 fuzes, which consisted of 6,250 fuzes delivered to the U.S. Government and 150 fuzes delivered directly to foreign governments. A total of 17,478 fuzes have been delivered through the first nine months of 2014. We occasionally experience lot acceptance test failures on this program due to the complexity of the product and the extreme parameters of the acceptance testing. Given the maturity of the product, we now generally experience isolated failures, rather than systematic failures. As a result, identifying a root cause can take longer and may result in fluctuating delivery performance from quarter to quarter. We expect to deliver approximately 23,000 to 25,000 fuzes in 2014. Learjet 85 In 2010, our U.K. Composites operation was awarded a contract for the Learjet 85 program. We manufacture composite passenger entry and over-wing exit doors for the Learjet 85, a mid-sized business jet built primarily from composites and featuring advances in aerodynamics, structures and efficiency. We began delivery during the second quarter of 2013. In April 2014, Bombardier conducted the first test flight for the Learjet 85. We anticipated completing deliveries on initial orders under this program in 2014; however, Bombardier provided us with a stop-work order during the third quarter of 2014, as they are internally evaluating the priorities of their development programs. 747-8 Wing-to-Body Fairing The segment has contracted with Boeing Canada Winnipeg to manufacture and assemble two major sections of the 747-8 Wing-to-Body Fairing. Initial production for these components will occur at our Jacksonville facility and upon completion these components will be delivered directly to Boeing's wide-body assembly line in Everett, Washington. The contract has a potential value, depending on production rates, in excess of $60 million. Initial deliveries under this program began in the second quarter of 2014 and we expect to ship six shipsets in 2014. 33--------------------------------------------------------------------------------LIQUIDITY AND CAPITAL RESOURCES Discussion and Analysis of Cash Flows We assess liquidity in terms of our ability to generate cash to fund working capital requirements and investing and financing activities. Significant factors affecting liquidity include: cash flows generated from or used by operating activities, capital expenditures, investments in our business segments and their programs, acquisitions, divestitures, dividends, availability of future credit, adequacy of available bank lines of credit, and factors that might otherwise affect the company's business and operations generally, as described under the heading "Risk Factors" and "Forward-Looking Statements" in Item 1A of Part I of our 2013 Annual Report on Form 10-K. We continue to rely upon bank financing as an important source of liquidity for our business activities including acquisitions. We believe this, when combined with cash generated from operating activities, will be sufficient to support our anticipated cash requirements for the foreseeable future. However, we may decide to raise additional debt or equity capital to support other business activities including potential future acquisitions. We anticipate our capital expenditures will be approximately $30.0 to $35.0 million in 2014, primarily related to machinery and equipment and information technology infrastructure. Included in this is approximately $11.6 million associated with investments in enterprise resource planning (ERP) systems primarily for our Distribution segment and, to a lesser extent, certain Aerospace facilities. We anticipate a variety of items will have an impact on our liquidity during the next 12 months, in addition to our working capital requirements. These could include one or more of the following: • the matters described in Note 11, Commitments and Contingencies, in the Notes to Condensed Consolidated Financial Statements, including the cost of existing environmental remediation matters and deposits required to be made to the environmental escrow for the Moosup facility; • contributions to our qualified pension plan and Supplemental Employees' Retirement Plan ("SERP"); • costs associated with new aerospace start-up programs; and • the extension of payment terms by our customers. We do not believe any of these matters will lead to a shortage of capital resources or liquidity that would prevent us from continuing with our business operations as expected. We regularly monitor credit market conditions to identify potential issues that may adversely affect, or provide opportunities for, the securing and/or pricing of additional financing, if any, that may be necessary to continue with our growth strategy and finance working capital requirements. Management regularly monitors pension plan asset performance and the assumptions used in the determination of our benefit obligation, comparing them to actual performance. We continue to believe the assumptions selected are valid due to the long-term nature of our benefit obligation. In October 2014, the Society of Actuaries ("SOA") finalized a new set of mortality tables. Mortality is a key assumption in developing actuarial estimates, and therefore could significantly impact the valuation of our obligations under the qualified pension plan and SERP. We will consider this new mortality data at our next measurement date, December 31, 2014. In 2013, the Company signed a $120.6 million contract to resell ten of the former Australia SH-2G(A) (now designated SH-2G(I)) aircraft, spare parts, a full mission flight simulator, and related logistics support to the New Zealand Ministry of Defence. Pursuant to the terms of its revenue sharing agreement with the Commonwealth of Australia, the Company was required to share proceeds from the resale of the SH-2G(I) inventory with the Commonwealth on a predetermined basis. During the third quarter of 2014, the Company settled the revenue sharing agreement with the Commonwealth of Australia and made a final payment of $5.3 million. As a result, no further revenue sharing payments will be due to the Commonwealth of Australia as the Company sells the remainder of the SH-2G(I) inventory. Over the course of the revenue sharing agreement, net of the benefits derived from our hedging arrangements, the Company paid approximately $32.1 million to the Commonwealth of Australia. Upon entering into the sales contract with the New Zealand Ministry of Defence, we agreed to provide unconditional letters of credit for the receipt of advance payments on this program. As we perform under the contract and meet certain predetermined milestones, the letter of credit requirements will be gradually reduced. As of September 26, 2014, the letter of credit balance associated with this program totaled $30.3 million. 34 -------------------------------------------------------------------------------- A summary of our consolidated cash flows from continuing operations is as follows: For the Nine Months Ended September 26, September 27, 2014 2013 2014 vs. 2013 (in thousands) Total cash (used in) provided by: Operating activities $ 43,469 $ 24,824 $ 18,645 Investing activities (100,370 ) (50,583 ) (49,787 ) Financing activities 56,229 19,584 36,645 Free Cash Flow (a): Net cash provided by operating activities $ 43,469 $ 24,824 $ 18,645 Expenditures for property, plant and equipment (22,188 ) (30,118 ) 7,930 Free cash flow $ 21,281 $ (5,294 ) $ 26,575 (a) Free Cash Flow, a non-GAAP financial measure, is defined as net cash provided by operating activities less expenditures for property, plant and equipment, both of which are presented on our Condensed Consolidated Statements of Cash Flows. See Management's Discussion and Analysis of Financial Condition and Results of Operations-Non-GAAP Financial Measures for more information regarding Free Cash Flow. Net cash provided by operating activities increased for the nine months ended September 26, 2014, versus the comparable period in 2013, primarily due to proceeds from the sales of SH-2G(I) inventory as we continue to perform under the New Zealand program and JPF program inventories. These improvements were partially offset by the application of customer advances previously received on the New Zealand SH-2G(I) program. Net cash used in investing activities increased for the nine months ended September 26, 2014, versus the comparable period in 2013. The increase was primarily related to the acquisition of the operating assets of B.W. Rogers. Net cash provided by financing activities increased $36.6 million for the nine months ended September 26, 2014, versus the comparable period in 2013, primarily due to an increase in borrowings under the Revolving Credit Agreement in 2014 as compared to the same period in the prior year. The borrowings in 2014 were used to fund the B.W. Rogers acquisition and working capital requirements. Financing Arrangements On November 20, 2012, we entered into a Credit Agreement (the "Credit Agreement") that includes a $400.0 million Revolving Credit Facility expiring July 31, 2017. The Revolving Credit Facility includes an "accordion" feature that would allow us to increase the aggregate amount available to $500.0 million, subject to additional commitments from lenders. The Revolving Credit Facility may be used for working capital, letters of credit and other general corporate purposes, including acquisitions. The Credit Agreement also includes a $100.0 million Term Loan Facility expiring on July 31, 2017, which is in addition to our Revolving Credit Facility. Principal payments, which started in the first quarter of 2013, of $2.5 million are due quarterly, with $55.0 million of the initial aggregate principal payable in the final quarter of the Term Loan Facility. We may increase the term loan by up to an aggregate of $100.0 million in accordance with the terms of the agreement. Interest rates on amounts outstanding under the Credit Agreement are variable. At September 26, 2014, the interest rate for the outstanding amounts on the Credit Agreement was 1.68%. At December 31, 2013, the interest rate for the outstanding amounts on the Credit Agreement was 1.72%. The financial covenants associated with the Credit Agreement include a requirement that (i) the ratio of Consolidated Senior Secured Indebtedness to Consolidated EBITDA, as defined in the Credit Agreement, cannot be greater than 3.50 to 1.00, (ii) the ratio of Consolidated Total Indebtedness to Consolidated EBITDA, as defined in the Credit Agreement, cannot be greater than 4.00 to 1.00, and (iii) the ratio of Consolidated EBITDA, as defined in the Credit Agreement, to the sum of (a) all interest, premium payments, debt discounts, fees, charges and related expenses and (b) the portion of rent expense under capital leases that is treated as interest expense, as defined in the Credit Agreement, cannot be less than 4.00 to 1.00. We were in compliance with those financial covenants as of and for the quarter ended September 26, 2014, and we do not anticipate noncompliance in the foreseeable future. 35 -------------------------------------------------------------------------------- Total average bank borrowings during the quarter ended September 26, 2014, were $218.8 million compared to $188.8 million for the year ended December 31, 2013. As of September 26, 2014, and December 31, 2013, there was $176.9 million and $217.6 million available for borrowing, respectively, under the Revolving Credit Facility, net of letters of credit. Letters of credit are generally considered borrowings for purposes of the Revolving Credit Facility. A total of $35.0 million and $36.8 million in letters of credit was outstanding under the Revolving Credit Facility as of September 26, 2014, and December 31, 2013, respectively. The letter of credit balance related to the SH-2G(I) New Zealand sales contract was $30.3 million at September 26, 2014. The letter of credit balance related to this contract could reach a potential $60.1 million over its three-year term. Other Sources/Uses of Capital We contributed $10.0 million to the qualified pension plan and $0.7 million to the SERP through the end of the third quarter. We do not expect to make any further contributions to the qualified pension plan during 2014. We plan to contribute an additional $0.1 million to the SERP in 2014. For the 2013 plan year, we contributed $10.0 million to the qualified pension plan and $2.3 million to the SERP. The decrease in contributions to the SERP is primarily the result of payments made to retirees in 2013 that were not repeated in 2014. In November 2000, our Board of Directors approved a replenishment of our stock repurchase program, providing for repurchase of an aggregate of 1.4 million common shares for use in administration of our stock plans and for general corporate purposes. There were no shares repurchased under this program during the first nine months of 2014. At September 26, 2014, approximately 1.0 million shares remained authorized for repurchase under this program. NON-GAAP FINANCIAL MEASURES Management believes the non-GAAP (Generally Accepted Accounting Principles) measures used in this report on Form 10-Q provide investors with important perspectives into our ongoing business performance. We do not intend for the information to be considered in isolation or as a substitute for the related GAAP measures. Other companies may define the measures differently. We define the non-GAAP measures used in this report and other disclosures as follows: Organic Sales per Sales Day Organic sales per sales day is defined as GAAP "Net sales of the Distribution segment" less sales derived from acquisitions completed during the preceding twelve months divided by the number of sales days in a given period. Sales days are the number of business days that the Distribution segment's branch locations were open for business and exclude weekends and holidays. Management believes sales per sales day provides an important perspective on how net sales may be impacted by the number of days the segment is open for business. Management uses organic sales per sales day as a measurement to compare periods in which the numbers of sales days differ. Free Cash Flow Free cash flow is defined as GAAP "Net cash provided by (used in) operating activities" less "Expenditures for property, plant & equipment", both of which are presented in our Condensed Consolidated Statements of Cash Flows. Management believes free cash flow provides an important perspective on the cash available for dividends to shareholders, debt repayment, and acquisitions after making capital investments required to support ongoing business operations and long-term value creation. Free cash flow does not represent the residual cash flow available for discretionary expenditures as it excludes certain mandatory expenditures such as repayment of maturing debt. Management uses free cash flow internally to assess both business performance and overall liquidity. CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS There have been no material changes outside the ordinary course of business in our contractual obligations or off-balance sheet arrangements during the first nine months of 2014. See our 2013 Annual Report on Form 10-K for a discussion of our contractual obligations and off-balance sheet arrangements. 36 --------------------------------------------------------------------------------CRITICAL ACCOUNTING ESTIMATES Preparation of the Company's financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Management believes the most complex and sensitive judgments, because of their significance to the consolidated financial statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Management's Discussion and Analysis and the Notes to Consolidated Financial Statements in the Company's 2013 Annual Report on Form 10-K describe the critical accounting estimates and significant accounting policies used in preparing the Consolidated Financial Statements. Actual results in these areas could differ from management's estimates. There have been no significant changes in the Company's critical accounting estimates and significant accounting policies in 2014. RECENT ACCOUNTING STANDARDS Information regarding recent changes in accounting standards is included in Note 2, Recent Accounting Standards, of the Notes to Condensed Consolidated Financial Statements in this report. |