Kaman Corporation

Good day and thank you for standing by. Welcome to the Command Corporation Q3 2023 conference call. At this time, all participants are in listen only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised to withdraw your question. Please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Matthew Pedersen, chief accounting officer and controller.

Please go ahead. Good morning.

Welcome to Command's third quarter 2023 earnings call. Leading the call today are Ian Walsh, Chairman, President, and Chief Executive Officer, and Carol Lane, Senior Vice President and Interim Chief Financial Officer. Before we begin, please note that some of the information discussed during today's call will consist of forward-looking statements setting forth our current expectations with respect to the future of our business, the economy, and other events. These include projections of revenue, earnings, and other financial items, statements on 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 third quarter 2023 results, included on Form 10-Q and the current report on Form 8-K, filed yesterday evening, together with our earnings release. We also expect to discuss certain financial measures and information that are non-GAAP measures, as defined in applicable SEC rules and regulations. Reconciliations to the company's GAAP measures are included in the earnings release filed with yesterday's Form 8-K. Finally, we posted an earnings call supplement, which provides additional context on our financial performance. You can find this presentation in the investor presentation section of our website. Now, I'll turn the call over to Ian Walsh.

Good morning, everyone, and thank you for joining our news call today. Our strong performance continued into the third quarter as we remain focused on optimizing our cost structure and consistent execution against our objectives, which are to drive overall improved profitability, free cash flow, and return on invested capital. Our results were led by continued strength in our engineer product segment. Based on this performance, we are revising our outlook for the full year and now expect higher adjusted EBITDA in the range of 102.5 million to 110 million, unexpected sales in the range of 765 million to 775 million. Net sales for the quarter grew 6.4% over the prior year period to 183 million, reflecting the contribution from aircraft wheel and brake and approximately 21% organic growth from our engineer product segment. These factors were offset primarily by lower JPF sales during the period, which was anticipated as this program continues to wind down. Continuing the trend from the second quarter, our end markets continued to perform well in the third quarter. Commercial, business, and general aviation in the third quarter saw better than 30% growth year over year. Our specialty bearings business continued to overperform as commercial markets continued to demonstrate robust demand. Industrial end markets improved notably in the third quarter with double-digit organic growth compared to relatively flat sales volume for the first half of the year, driven by growth in miniature bearings volumes for industrial solutions. Our medical defense end markets continued to grow in the low to mid-single digits. We remain focused on our transformational strategy, which includes investing in the high growth high margin areas of our business, optimizing our cost structure, and eliminating the historic sources of variation within our business. I am pleased to report that these efforts continue to yield results in the third quarter, with adjusted EBITDA dollars and margin improving meaningfully over the prior period. In the third quarter of 2023, we achieved adjusted EBITDA of 25.2 million, or 13.8% of sales, compared to 19.5 million, or 11.3% of sales in the prior year. As we move into the fourth quarter, we are pleased with the progress we have made so far this year and still have remaining objectives to accomplish as we reposition our company. Beginning with engineered product segment, we continued to invest in opportunities for organic growth to drive favorable mix and margin performance to our consolidated results. Our investment strategy also focuses on fostering innovation and developing strategic partnerships for the next generation of products. In our precision products segment, we have made significant progress to right size our operations following the wind down of the JPF and K-Max production programs and expect to complete the consolidation of our JPF production facilities in the first half of 2024. We remain on track to realize $22 to $25 million of cost savings in 2024 from our cost reduction programs that we previously disclosed. Turning to our segment performance and beginning with engineer products, in the third quarter, we continued to demonstrate strong performance with overall sales growth of 34.3%, of which approximately 21% was organic. Higher sales volumes were broad-based across our business units, led by strength in traditional self-lubricating bearings and PMA aftermarket programs. Gulfstream continues to be a wonderful customer for us with our high load capacity, self-lubricating flap track rollers, We continue to make progress on our TDH, or titanium diffusion hardening innovation, in both the medical and space propulsion applications. We have over 30 applications being tested, and we're showing promising results of TDH as a replacement in orthopedic surgery where many patients are allergic to cobalt chrome plated parts. Higher segment level sales generate a stronger profit, with engineering products adjusted EBITDA increasing 76.5% to 38.4 million. This stronger volume also demonstrated the operating leverage in our business, as margins expanded by 740 basis points year-over-year to 31.1%. In our precision product segment, sales declined 41.5% to 27.1 million, which was attributed to the anticipated decline in JPF volume compared to the prior year. Excluding the effects of JPF, segment-level sales increased 9.7 million driven by higher KMAX aftermarket sales and higher fireburst deliveries, offset partially by lower sales and legacy fusing programs during the period. We recently completed delivery of our first tranche of fireburst units to our overseas customer. Segment level adjusted EBITDA was negative $2.5 million compared to $6.1 million in the prior year. Lower segment adjusted EBITDA was a result of lost operating leverage as we wind down the JPF program and work to right size our facility footprint for remaining legacy programs. As we have noted, this is a focus area for us and a meaningful portion of our 22 to 25 million of cost savings identified is generated from the consolidation of our footprint. Turning to our structure segment, third quarter sales were 32.3 million compared to 33.7 million in the prior year. The modest decline from the prior year was primarily a result of lower A-10 and UH-60 Black Hawk deliveries, partially offset by higher Rolls-Royce and Sikorsky volume. Our Vermont facility continues to be our benchmark as they grow and win new, more profitable programs, such as a new contract with L3 Harris for their new ground-based mid-course defense radomes and a Rolls-Royce Trent 7000 fan track liners for the Airbus A330neos. Third quarter segment level adjusted EBITDA was negative 2.2 million compared to breakeven results in the prior year period. As we have noted throughout the year and reflected in our guidance, we are working to optimize production of legacy programs that have driven our historical variability in this segment. We continue to anticipate full year segment level profitability at around breakeven for the year. As we enter the final quarter of 2023, we are pleased with the measurable progress we have made across our company. Our positive momentum can be attributed to the ongoing execution of our strategic initiatives, streamlining our operations, and investing in our high-performing businesses to enhance the overall quality of our earnings. Looking forward, we maintain our commitment to several key objectives. First, we are disciplined in deploying our capital resources to the most promising growth opportunities within our engineered product segment. Our emphasis continues to be on fostering innovation to drive substantial year-over-year organic growth. achieve margin improvement, and generate strong cash flows. In the precision product segment, we are committed to transitioning our business by making prudent and targeted investments in next generation products. Our decisions to consolidate our JPF facilities and conclude KMAX production are aimed at enhancing operational performance and reducing variability. These actions will reposition precision products business units for profitable growth in future years. We also expect to benefit from the continuing investments being made in our cargo UAV system, a purpose-built autonomous medium lift logistics vehicle, which has targeted military and commercial customer requirements in a large adjustable in-market. We are excited to recently receive a contract with our partners at Nearest Autonomy by the U.S. Army Futures Command to demo in 2024 our cargo UAV capable of moving loads 800 pounds and flying distances over 100 miles. Our cargo UAV is being designed to carry 800 pounds and has a max range of 500 miles. Within our structures segment, we continue to diligently implement best practices with the aim of ensuring that all three of our structures businesses operate consistently in a healthy manner. Now I'll turn the call over to Carol for a closer look at the numbers. Carol.

All right. Thank you, Ian. Good morning, everyone. I'll walk you through our third quarter results before turning to our outlook for 2023. Third quarter sales were $183 million, up 6.4% from the prior year. Aircraft wheel and brake, which we acquired in mid-September 2022, contributed sales of $16.9 million. Organic sales were relatively flat, with strong organic revenue growth across our engineered product segment for approximately 21%, offset by lower sales in our precision product segment related to the previously discussed wind down of the U.S. government JPF program, which was anticipated, and a slight reduction in sales in our structure segment. Operating income in the third quarter was $11.9 million, including $1.9 million from aircraft, wheel, and brake. That's an increase of $12.6 million compared to a slight operating loss in the prior year. Adjusted EBITDA in the third quarter was $25.2 million, an increase of almost 30% compared to the prior year of $19.5 million. EBITDA margin increased 250 basis points to 13.8%. Higher profitability stemmed mostly from the benefits of organic growth, greater operating leverage from higher sales, and cost-saving measures taken over the past 12 months that are intended to enhance our operating performance. We continue to execute on our previously announced cost savings initiatives. We expect total savings of $22 to $25 million in 2024, with over 12 million to be realized in 2023. Turning back to our results, gross margin was 35.3%, which increased 350 basis points compared to the prior year. This was attributable to the addition of aircraft wheel and brake, higher organic volume in our engineered product segment, and benefits from our cost savings initiatives. Selling, general, and administrative expenses were 42.5 million, A decrease of 13.3% due to the absence of corporate development costs incurred in the prior year, which were associated with the acquisition of aircraft wheel and brake. As a percentage of sales, lower SG&A was due to operating leverage on higher volume, cost control measures, and lower corporate development costs. Interest expense in the quarter was $9.4 million compared to $3.6 million in the prior year. as a result of higher interest rates and the additional debt from the aircraft wheel and brake acquisition. As we noted last quarter, we refinanced our debt in the second quarter of this year and extended our maturity to 2028, providing us ample flexibility through our deleveraging plans. Third quarter free cash flow was $3.8 million, and year-to-date free cash flow is $9.8 million. We currently expect to settle our convertible notes with available borrowing capacity under our credit agreements. However, we continue to assess other potential options for the refinancing of these instruments prior to their scheduled maturity in May 2024. With the extension of our credit agreement, we maintain sufficient capacity to use proceeds from this facility to repay the convertible notes and satisfy our working capital requirements. During the third quarter, we reported gap net income of 1.5 million, or five cents per diluted share. That compares to a loss of 280,000 or $0.01 loss per diluted share in the prior year period. Adjusted net income during the period was $2.7 million or $0.10 per diluted share, and that compares to $8.1 million or $0.29 per diluted share in the prior year period. Lower earnings per diluted share in 2023 was attributable to higher interest expense, partially offset by stronger operating results. For a full reconciliation of our GAAP to non-GAAP earnings, please review our earnings press release. Now turning to our outlook. We are revising our full year 2023 outlook to account for the strength we are seeing in our engineered product segment. As Ian highlighted, our end markets are demonstrating strong performance, we're successfully increasing our market share in engineered products, and our overall backlog remains robust. Our primary focus continues to be expanding our highest growth businesses, enabling us to generate more substantial returns. At the same time, we're optimizing our cost structure to align with the size and requirements of our business. Our results in the first nine months of this year are ahead of expectations, with a portion of our performance attributable to $7.2 million of EBITDA from our JPF program as we delivered against commitments in the first half of 2023. While we do not expect significant JPF volumes in the fourth quarter, we now expect total revenue in the range of $765 million to $775 million, driven by the strength we're seeing in engineered products. We've increased our expectations for net earnings to $6.5 million to $12.2 million in diluted EPS of $0.23 per share to $0.43 per share, or $0.40 per share to $0.60 per share on an adjusted basis. This increase is primarily driven by our expectation of drop-through from the engineered product segment, coupled with our cost optimization efforts, offset partially by interest expense. Our expectations of engineered products drop-through and cost reduction is also driving our improved adjusted EBITDA outlook, which is now in the range of 102.5 million to 110 million. This updated outlook considers both strength in engineered products and some incremental risk related to the precision products and structure segments. Our expectations for operating cash flow of $60 million to $70 million and free cash flow of $35 million to $45 million remains consistent with our prior outlook as we continue to make investments that will support future growth in our engineered product segment and improvements in our structure segment. As a reminder, to improve the reliability of our outlook and improve transparency, Our previous outlook excluded discrete items which have historically been sources of variation. Specifically, these included unawarded or uncertain JPF DCS orders and sales of the two remaining KMAX aircraft held in inventory. Our current outlook now considers the sale of an additional KMAX aircraft in Q4, as well as the delivery of a limited volume of JPF orders currently in backlog. With that, I'll turn the call back over to Ian for closing remarks.

Thanks, Carol. With one quarter left to go in 2023, we continue to see that our transformational strategy is producing stronger results, better level loading our quarters by reducing our historical sources of variation and aligning with our expectations. Our team remains focused to deliver on our long-term strategy to maximize shareholder value. The third quarter highlights the exceptional performance of our engineer product segment, emphasizing its substantial earnings power and growth potential. This segment remains a key focus for our ongoing investment. We are confident that as we make future improvements in our precision products and structure segments, we will be well positioned to achieve significant earnings growth while steadily reducing our debt burden. Just as important, I am thrilled with our progress on the cultural transformation of our company as we strive toward becoming a high performance team with consistent execution and innovation. We believe that our future success depends on the core capabilities and dedication of our workforce who reflect the values of our founder, Charles Command, in their deep desire to solve our customers' most difficult problems. We are truly appreciative of the many contributions and collaborative teamwork shown by our colleagues through the first three quarters of 2023. It has been instrumental in our transformational journey. With that, I'd like to open the line for questions. May we have our first question, please?

Thank you. We will now conduct the question and answer session. To ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster.

Our first question comes from Steve Barger from KeyBank Capital Markets. Please go ahead.

Steve? Okay, please stand by while I compile the Q&A roster.

Our next question comes from Tony Bancroft from GameCo Investors, Inc. Please go ahead.

Good morning, gents. Nice job in the quarter. Just one question. I came in late, so I just missed. I just heard Carol at the very end discussing the convertible refinancing. Would you mind just going through maybe just the mechanics, what the plan is and what the interest rate increase is going to be and the terms for it to refinance that.

Hey, Tony, good morning. Look, I think what we said is probably not anything really particularly new. We have enough capacity under our refinance credit agreement to deploy our revolver against those convertible notes, and as we sit here today, there's no reason to believe that's not our prime path. That said, we're getting economic benefits from our convertible notes today. You know, I think we've got time to evaluate, you know, if there's anything different that we would want to do in that area. But as we sit here today with the credit capacity we have, we feel comfortable that's a good option for us. So probably not going to get into terms and rates here on the call, but feel good about the options we've got in front of us. Okay. Thanks so much. Appreciate it. You bet.

Thank you. One moment for our next question. We have Steve Barger from KeyBank Capital Markets. Please go ahead.

Hi, good morning, guys. Can you hear me now? Yep, loud and clear. Hey, good morning. This is Jacob Moore on the call for Steve. Thanks for taking the questions.

You bet.

So first, two quick ones here on the guidance change. I think implied 4Q sales have a sequential step-up. Do you expect that to happen in all three segments, or maybe what are the dynamics by segment if not?

Well, yeah, we generally don't issue segment-level outlook, but you heard us talk about the strength in engineered products, and that has really been the economic driver for us here today. We expect that to continue in Q4. We did mention that we've got one of the KMAX helicopters in our outlook. You know those helicopters sit in our precision product segment. But really, when you think about all three elements of our outlook, the sales, the EBITDA, and the free cash flow, It's our confidence in our engineered product segment and the progress we've seen year to date that really allows us to elevate our outlook in sales, elevate our outlook on EBITDA, and to hold our outlook on free cash flow.

Yeah, Jacob, this is Ian. I'll just add on structures and precision products, a little bit more color maybe. Like, you know, we continue to focus very heavily on the get healthy on our structures businesses. We feel really confident. that all the work that we've done early this year to correct material flow, manpower issues, getting back to tack time, for example, in the H-60s, A-10 movement and deliveries from Wichita to Jax, all really start to manifest themselves in the fourth quarter as a result of all the good work we've done earlier this year, just dealing with a lot of challenges. So that's good. And precision products, same thing. You know, really transitioning a lot of our work – and effort on the quality signature for our fusing programs and transitioning, like I said, from KMAX to cargo, JPF wind down, and getting cost out of that business. So I think we're in good shape.

Got it. Understood. The answer to that kind of flows into my next question, which was the implied big step up in 4Q free cash flow. Confidence in there is coming from the KMAX sale. Is that right?

Well, again, the confidence is really coming from the engineer product segment, and we've got a good line of sight to our free cash flow outlook. We consider all three segments, obviously, the risks and opportunities. Yes, the KMAX aircraft sale contributes to our outlook, but we're also expressing a range, so we've got multiple pathways to get there. But Ian's talking just a little bit about structures. We don't talk a lot about cash flow at the segment level, but I can tell you that Structures has been a drag on cash year to date. We don't expect it to be a drag on cash flow in the fourth quarter. And so we expect more of the real strength we're seeing out of engineered products to drop through in the form of free cash flow in Q4.

Okay. Okay. Got it. Moving to the segments, just starting on engineered products, margin looks pretty good this quarter. How sustainable is that? Do you expect something similar in 4Q, or are there variables that could prevent sustainable growth, margin growth there?

Yeah, I mean, you can kind of back into your margin expectation based on the sales outlook range and the EBITDA outlook range there. But what I can tell you is the demand environment remains robust in engineered products. As strong as the organic sales have been, I think up 21%. The orders have been very strong. We're running it year-to-date, book-to-bill, north of 1.0. And even with the increased velocity that we've seen through our shops and the engineered product side, our largest business unit, Comatics, has seen its sold overdue actually increase materially over the course of the year. So in other words, there are orders that our customers are waiting for us to fulfill, and we just need to get them through the shops. So the challenge for us has really been working with our suppliers and the supply chain to get the support we need to hit the volumes and to get the labor necessary. Coming out of COVID, it's been an industry trend, getting the labor to process these volumes. So as we look ahead, Q4 and beyond, we see on the back of a commercial aerospace macro story, pretty solid growth ahead of us. And given the fact that we have not just OEM, but also aftermarket exposure, you know, we fully intend to get full value for our pricing and to ensure that we're covering the price-cost mix equation adequately. So, feel pretty solid.

Got it. That makes sense. Moving to precision products, I think margins are being dragged down there by R&D related to the cargo UAV program. So, I mean, first, is that correct? And then, if so, how long does that persist?

Yeah, you got it right that the cargo sits within our precision product segment. Now, the big story in our precision product segment, as you well know, is the JPF volumes relative to – we've talked about this a lot, but JPF volumes have come down substantially as the U.S. government program winds down. And so the challenge is really maintaining a solid quality and cost signature in the legacy fuse business. We're putting a lot of effort around that. You – are aware of our prior disclosures around the consolidation of JPF and attacking cost there to that site consolidation in our Middletown facility. But you're right, the cargo R&D program sits within precision products. And though we get a significant proportion of our funding from the US government on the contracts, the prototype contracts that we have underway, any company funded R&D associated with the cargo does flow through the precision products line. I'll hand over to Ian to talk a little bit more about cargo and sort of the trajectory that we see there, but that's sort of the accounting of it.

Yeah, exactly. So, you know, we obviously have a very, you know, important program with cargo underway. As we've said from the beginning, our investment strategy is milestone-based. We just talked about the contract we've got with the U.S. Army with our partners in the Earth Autonomy, which is very exciting. You know, we've also talked about first flight. I know people are interested in that. We were months away, obviously, as the program ramped up. We're weeks away, and now we're days away, which is very exciting. But I think from an R&D perspective, we're being very, very thoughtful, very mindful around not only the investment necessary to get cargo to market and hit certain milestones and our competitive flyoffs and things for next year, but And also, obviously, what's going on underneath with the rest of the fusing program. But really, it's a balance with our engineering products. Our engineering product segment also has a very healthy IR&D budget. All those businesses that sit in that segment have a very robust pipeline of innovations and things they're attacking from a share perspective or a customer perspective. So really balancing best we can with cargo and engineering products.

Okay, got it. That's helpful. While we're on the cargo or maybe the MOSA program, can you just remind us the timeline milestones within the MOSA program that you're planning to hit? And then maybe a follow-up to that, is this Army demonstration basically just a larger scale model of the current design?

Okay, so two things. One is from a milestone perspective, yes, we are tracking towards with the U.S. Marine Corps on MOSA, which is a fly-off no set time yet for next year, but we anticipate it being in later half of next year. So we're tracking the schedule there. And then from there, as I've expressed before, typically what happens is the winner, it could be one or it could be others, would then get follow-on contracts to build multiple variants to be field tested, right? And that's the next step. That would be over a year, year and a half or so. You collect all that data, use these prototypes in different environments, get that customer feedback, and then you go to kind of a low-rate production environment, which would be in a 25, 26 timeframe, typically. RME, a little bit same but different. So the demonstration that we've been invited to, which by the way is invite only, you have to submit certain proposals. It's not just an open-ended competition or demonstration, so you have to be invited. The same MOSE that we have, as I mentioned, the capability there hits, the requirements for what the Army is looking for for a medium lift platform, Thomas platform. So this is Army Futures Command. This is a demonstration that they've been hosting to really look at technology because they have the same problem that Marine Corps has, which is how do you move things around an extended battlefield? So extended logistics, contested logistics, things like that. So what we don't know yet is after the Army milestone, where they go from there. It's a little bit different process, but I can tell you that the Army's demand for unmanned cargo capability is probably the largest in the services just by nature of what they do. So that's kind of our path and milestone with those two programs on the service side.

Great. That's it for me. Thank you for taking the questions.

Thanks, Jacob. You bet.

Thank you. As a reminder, if you would like to ask a question, please press star 1-1 and wait for your name to be announced.

I am showing no further questions at this time.

I would now like to turn the conference back over to Matthew Pedersen for closing remarks.

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

This concludes today's conference call. Thank you for participating. You may now disconnect.