Kaman Corp

F:KA1

Earnings Call Transcript 2023-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the Kaman Corporation Q2 2023 Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Jamie Ranno, Assistant Controller. Please go ahead.

[James Ranno, Assistant Controller]

Good morning. Welcome to Kaman's second quarter 2023 earnings call. Leading the call today are Ian Walsh, Chairman, President and Chief Executive Officer; and Jamie Coogan, Senior Vice President, Chief Financial Officer and Treasurer. 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. Additionally, the company revised its prior period results due to errors identified related to inventory, which were determined not material to our previously issued financial statements.

These items are described more fully in the company's latest filings with the Securities and Exchange Commission, including the company's second 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 8-K.

Finally, we posted an earnings call supplement on our website, which provides additional context on our financial performance. You can find this presentation at www.kaman.com/investors/quarterlyearningscalls.

Now I'll turn the call over to Ian Walsh.

[Ian Walsh, Chairman, President and Chief Executive Officer]

Good morning, everyone, and thank you for joining our second quarter 2023 earnings call. Performance in the quarter was very strong, and we're delivering on our commitments to drive improved profitability and cash flow performance.

Based on this performance, we are revising our guidance for the full-year and now expect higher adjusted EBITDA in the range of $97.5 million to $107.5 million on sales volumes, consistent with our prior expectations. Net sales grew 21.4% over the prior year period to $195.2 million, benefiting from the contribution of Aircraft Wheel & Brake organic growth of 8.2%.

Results in the quarter demonstrate the continued strength we are seeing across our Engineered Products segment, which posted top line growth of 48.7% or 25.1% organically over the prior year. We are pleased to report that all of our end markets have performed well during the first half of the year, led by commercial, business and general aviation, where we benefited from the Aircraft Wheel & Brake acquisition and organic growth which was particularly strong across our Engineered Products portfolio, with the most meaningful growth coming from our engine aftermarket products.

We see momentum in the defense end market with double-digit growth in both the quarter and first half of the year. The success is primarily attributed to the strength of our core defense portfolio, which helped to offset softness in our safe and armed devices related to the wind down of the JPF program.

In the medical end market, we remain in a positive trajectory with growth in the first half exceeding 10%. Stronger medical sales were attributed to higher volume on our miniature bearings and springs, seals and contacts used in medical implantables and devices.

Last year, industrial end market sales remained steady with modest organic growth in the period. We also continue to work diligently to reduce our costs and improve efficiency, and I'm pleased to report that these efforts led to an improvement in our net earnings for the period and a meaningful improvement in both adjusted EBITDA dollars and margins.

We achieved adjusted EBITDA of $32 million or 16.4% of sales in the second quarter of 2023 compared to $16.1 million or 10% of sales in 2022. We've outlined and continued to execute on our strategic initiatives aimed at improving our profitability and streamlining operations to reduce variability.

First, we disclosed our plan to consolidate our JPF operations into a single facility. This will enable us to maintain operational readiness while significantly cutting down program costs as the volumes wind down. We remain on track to our plan for the facility closure and have begun to realize cost savings for these actions. We continue to deliver on our remaining JPF backlog and have recognized approximately $7 million in EBITDA related to this program in the first half of the year, which is not expected to repeat in the second half.

We continue to pursue direct commercial sales of our JPF to allied countries and will provide further information when we receive these orders. As we've disclosed previously, we have made the hard decision to discontinue production of our K-MAX aircraft. We successfully sold one aircraft during the second quarter, and we are actively pursuing the sale of the two remaining helicopters, which could provide incremental cash flow for the year.

Our air vehicles team continues to work to pivot to higher-margin growth opportunities going forward. Delivering our cost reduction commitment remains an important focus for the team. To date, the actions we have taken are expected to provide annual savings between $22 million and $25 million by 2024. And through the second quarter, we are on track to deliver these savings.

Additionally, we are working to identify additional cost savings and margin enhancement opportunities that could provide benefits in excess of our previously announced programs. Turning to our segments.

And beginning with Engineered Products, we are extremely pleased with the strong segment performance that continued through the first half, leading to overall sales growth of 48.7% or 25.1% organically. We saw growth across our Engineered Products portfolio in the second quarter as we are recovering back to pre-COVID levels for our commercial aerospace and defense products and are benefiting from our additional market share wins.

Higher sales led to improved profitability with operating margins of 23% and adjusted EBITDA margin in excess of 30%. Organic growth in the quarter was primarily driven by higher demand for our self-lubricating bearings and engine aftermarket products.

Our segment level backlog remains robust as we -- as a result of strong demand and the addition of Aircraft Wheel & Brake. We expect to see continued strong performance for this segment in the second half of the year given the year-to-date strength and the continued demand for our products.

Over the long run, we expect this segment to grow in the high single-digit to low double-digit range. In our Precision Products segment, sales declined 32%, which is almost entirely due to the anticipated wind down of JPF program. Segment operating income and adjusted EBITDA were negative $1.9 million and negative $1.1 million, respectively, as we continue to make investments in next-generation technologies.

The segment continues to be an area of focus for us to improve costs through the footprint consolidation project and working capital improvements with the succession of K-MAX production, which we anticipate will drive improved operating results in the coming quarters.

In our Structures segment, sales of $33.6 million improved both sequentially and year-over-year by 1% and 13%, respectively. Segment level profitability continued to be pressured as we reported a small operating loss of $106,000 and adjusted EBITDA of $675,000. Segment performance in the quarter benefited from the receipt of an insurance claim settlement for costs incurred in the prior year related to a fire at one of our suppliers. As we move into the second half of 2023, we are pleased with the progress we have made so far this year.

The positive outcomes can be attributed to our transformational strategy to reduce the variation in our business and improve our quality of earnings, free cash flow, the strong growth momentum in our Engineered Products segment and the successful execution of planned actions initiated in 2022.

As we look ahead, we remain focused on several key objectives: Our first objective is to ensure ample capital resources are allocated to capitalize on the most promising growth opportunities within our Engineered Products segment. We continue to foster innovation and strategic partnerships with customers to drive robust year-over-year organic growth, high margins and strong cash flow generation.

We are dedicated to transitioning our Precision Products segment by making thoughtful and targeted investments in next-generation products. The JPF facility reduction plans and the conclusion of K-MAX production were all strategic moves to improve our operating performance. These actions will reposition the segment for more profitable growth in the remaining programs as we seek to benefit from the investments we are making in future autonomous components and the unmanned KARGO UAV platform.

In our Structures segment, we are diligently implementing best practices, aiming for all three of our structures businesses to operate in a healthy, consistent manner. Our focus also includes reducing our leverage and interest expense after the acquisition of Aircraft Wheel & Brake.

In the quarter, we successfully refinanced our credit facility. I am proud of the hard work the team put forward in securing the $740 million commitment with the amendment of our revolving credit agreement extending the maturity to 2028, while providing sufficient access to capital to repay our 2024 convertible notes and meet our working capital requirements, which Jamie will detail later.

Our company has successfully navigated some difficult challenges over the past few years, and I am proud of the progress our team has achieved in a short time span. Our employees' dedication, resilience and ingenuity have been instrumental to supporting the transformation of command.

Now I'll turn the call over to Jamie for a detailed analysis of the numbers. Jamie?

[James Coogan]

Thank you, Ian, and good morning, everyone. Today, I will walk you through our second quarter results before turning to our outlook for 2023. Second quarter sales were $195.2 million, up 21.4% from $160.8 million in net sales from the prior year. Higher sales in the quarter were attributable to organic growth of 8.2%, primarily in our Engineered Products segment and the $21.2 million of contribution from our Aircraft Wheel & Brake acquisition. Aircraft Wheel & Brake revenue was little stronger in the second quarter as we pulled forward some volume to make way for their ERP go-live in the third quarter, which was well executed.

This was partially offset by the expected lower JPF volume. Operating income in the second quarter was $17.6 million compared to $1.9 million in the prior year. Adjusted EBITDA in the second quarter was $32 million compared to just $16.1 million in the prior year. This improved performance reflects the benefit of strong organic growth, cost-out measures we have taken to improve margin and better leveling of our quarterly performance. EBITDA margin increased to 16.4% from 10% in the prior year.

We continue to execute on our cost savings initiatives and continue to expect total savings of $20 million to $25 million in 2024, with around $12 million to $15 million to be realized in 2023.

Turning back to our results. Gross margin was 37%, which increased 480 basis points compared to the prior year. This was attributable to the addition of Aircraft Wheel & Brake, higher organic volume in our Engineered Products segment, and benefits from our cost savings initiatives. Selling, general and administrative expenses were $41.6 million or 21.3% of sales compared to $39.3 million or 24.4% of sales in the prior year.

Higher dollar SG&A was related to the addition of Aircraft Wheel & Brake. As a percentage of sales, lower SG&A was due to the leverage on higher volume, the benefit from our cost control efforts, and lower corporate development costs. Interest expense in the quarter was $10.3 million compared to $2 million in the prior year as a result of higher interest rates and the added debt from Aircraft Wheel & Brake.

During the period, we refinanced our debt and extended the maturity to 2028, providing us ample visibility to execute on our deleveraging plans. Free cash flow during the period was $17.4 million, which benefited from the sale of a K-MAX aircraft in the quarter.

Our convertible notes went current this quarter. We're continuing to evaluate our options for the refinancing of this instrument. And with the amendment to our credit facility, we maintain sufficient capacity to use proceeds from the facility to repay the convertible notes and satisfy our future working capital requirements. We intend to capture the benefits of the lower coupon rate on the convertible notes until we come to a refinancing decision on this instrument.

During the second quarter, we reported GAAP net income of $5.3 million or $0.19 per diluted share compared to $3.8 million or $0.13 per diluted share in the year-ago period. Adjusted net income during the period was $6.2 million or $0.22 per diluted share compared to $8.5 million or $0.30 per diluted share in the prior year period. Lower earnings per diluted share in 2023 was attributable to the higher interest expense and lower pension income, partially offset by the stronger operating results we've seen in the year-to-date and quarter periods.

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 guidance. As Ian highlighted, our end markets are demonstrating strong performance. We are successfully increasing our market share in Engineered Products segment, and our overall backlog remains robust.

Our primary focus remains on expanding our highest growth businesses, enabling us to generate more substantial returns. At the same time, we are diligently optimizing our cost structure to align it with the size and requirements of our business. Our results in the first half were ahead of our plan with a portion of our performance attributable to $7.2 million of EBITDA from our JPF program as we delivered against our commitments and a modest pull forward in volume from Aircraft Wheel & Brake ahead of their Q3 ERP go-live.

Looking at the back half of the year, we do not expect the JPF volume from the first six months to recur in the second half. As a result, we continue to target top line growth in 2023 with total revenue in the range of $730 million to $750 million, consistent with our prior expectations.

We have lowered our expectations for net earnings to $3.7 million to $11.3 million and diluted EPS to $0.13 per share to $0.40 per share or $0.29 per share to $0.56 per share adjusted due to the higher expectations for interest expense. This increase in our interest expense is offsetting the increase we expect in operating income from our Engineered Products segment, which is driving our higher expected adjusted EBITDA now in the range of $97.5 million to $107.5 million.

Our expectations for operating cash flows of $60 million to $70 million and free cash flow of $35 million to $45 million remain consistent with our prior guidance as the higher interest expense is offset by the cash benefit of improved performance in the cash collection on the sale of one K-MAX aircraft.

As a reminder, to improve the reliability of our guidance and improve transparency, we continue to exclude discrete items, which have historically been high sources of variation. Specifically, these include unawarded or uncertain JPF DCS orders and the sale of the two remaining K-MAX aircraft held in inventory.

We also continue to assume no margin contribution from our Structures segment despite the approximately $800,000 of EBITDA we earned in the year-to-date period. We expect to achieve success in these areas, but they are not incorporated in our guidance for 2023.

With that, I'll turn the call back over to Ian for closing remarks.

[Ian Walsh, Chairman, President and Chief Executive Officer]

Thanks, Jamie. As we progress through 2023, we are pleased to see that our strategic plans are yielding strong results just as we anticipated. Our team remains aligned, steadfast and dedicated to executing on our long-term strategy to improve total shareholder returns as we turn the corner on our transformational journey.

The outstanding performance of our Engineered Products segment in this quarter demonstrates its earning power and growth potential and remains a focal point for our continued investment. As we continue to make improvements in our Precision Products and Structures segments, we are confident that we will be well positioned to achieve substantial earnings growth and steadily reduce our debt.

We are actively building a culture of enhanced internal discipline, controls and leadership. Our future success will always depend on the talent and dedication of our workforce, and we are immensely grateful for their contributions and teamwork.

With that, I'd like to open the line for questions. May we have the first question, please?

[Operator]

[Operator Instructions] And our first question comes from the line of Steve Barger with KeyBanc Capital Markets. Your line is now open.

[Jacob Moore, KeyBanc Capital Markets]

Hi, good morning. This is Jacob Moore on for Steve. Thanks for taking the questions.

[James Coogan]

Thanks, Jacob.

[Jacob Moore, KeyBanc Capital Markets]

Yes, of course. Based on your updated but mostly maintained full-year guide, I think that implies a slightly worse second half than first. So my first question is, is there something unusual in Engineered Products 2Q performance that drove this outcome that's not going to continue in the back half? Was that all pull forward from 3Q?

And then a close second to that is on Precision Products. Should we expect similar performance on the operating income line with JPF essentially out of the picture at this point?

[James Coogan]

Yes. So I'll start, Jacob, with Engineered Products, right? First half results did benefit from the increase in sales we saw on our higher-margin engine aftermarket components. Those were a strong contributor for us in the first half of the year, and specifically in the second quarter. And we do have the opportunity to repeat the performance in that product offering in the back half of the year. However, we're currently forecasting that at a slightly lower volume for the product.

In addition, and as we mentioned in our prepared remarks, we did pull in a little bit of sales associated with Aircraft Wheel & Brake into Q2 from Q3 in order to kind of derisk the ERP go-live as we continue the integration efforts of that. One of the big components there was getting their new ERP up and running. And that was well executed by the team here in the third quarter. And then finally, sales of our springs, seals and contacts, and these are typically for our medical implantable devices.

Those typically have a very strong first half of the year with a little bit of softness in the back half. All in all, though, we are working really hard to balance our performance front half to back half. And this requires some form of change in organizational mindset as we work through our forecasting, planning processes.

We believe that the strength in the first half of the year does derisk our expected performance in the second half. And at this point, kind of halfway through the year, we are comfortable with where we are, but there -- it's fair to say that there's a disproportionate opportunity relative to the guide on the upside versus the downside. However, we do want to remain disciplined in the approach to guide for the full-year given the lessons learned.

[Jacob Moore, KeyBanc Capital Markets]

Okay. Yes, that's helpful, Jamie. Thank you. And then maybe if I could, just on Precision Products, should we expect similar performance on the operating income line in the back half?

[James Coogan]

Yes. So on the JPF perspective, right, that did include $7 million in the first half of the year related to JPF. And as we go through the back half of the year, we do expect performance -- the underlying performance of the business had some EAC retro adjustments and other items in the first half, which drove away some of the benefit we expected from JPF. So it's probably fair to think that on a net-net basis, it will be largely in line from half to back half for that segment.

[Jacob Moore, KeyBanc Capital Markets]

Okay. Got it. Thank you. And then for a second one, just on the balance sheet. I appreciate the color on the convertible notes. So just with the understanding that you want to pay down debt this year and improve your leverage, can you comment on the sustainability of the cash flow you generated in 2Q? Given the sale of that K-MAX and how you expect the back half to look from that perspective?

[James Coogan]

Yes. Absent the K-MAX, we kind of were largely in line with our expected cash flow performance in the first half. We've historically been a user of cash in the first half of the year. A lot of that has come down, though to the parts of the business that we are currently in the process of working our way through, whether that be K-MAX production, JPF production.

You may recall historically, those were significant users of cash as we built up inventory typically for deliveries in the back half of the year. That decision we made in the front half, we had some cash commitments that were already on the hook. We believe that the actions we've taken will improve the kind of cadence of cash earnings in future periods.

And when we look at our Engineered Products businesses, largely, their conversion metrics are significantly greater than what Kaman has historically seen for cash conversion on an annualized basis. So we feel good. We think that, that cash flow is sustainable in future periods, and we are looking to the back half of the year for continued cash generation, which we will use to continue to delever.

[Jacob Moore, KeyBanc Capital Markets]

Okay, understood. Thanks for taking the questions. I have some more. But I'll hop back in line.

[James Coogan]

Got it, thanks.

[Ian Walsh, Chairman, President and Chief Executive Officer]

Thanks, Jacob.

[Operator]

[Operator Instructions] And we have a follow-up question from Steve Barger. Your line is now open.

[James Coogan]

Yes. Jacob, we did get word this morning that some of the other analysts are on other calls this morning. And so there were some conflicts relative to timing. So I'm happy to take any follow-up questions you might have.

[Jacob Moore, KeyBanc Capital Markets]

Understood. Thanks. I appreciate that. So first one, just on end markets, specifically in Engineered Products. It looks like commercial area has been running pretty nicely for Kaman lately. Can you just comment on the sustainability of that above-trend growth? Ian, I know you mentioned a high single-digit, low double-digit range over the long-term. So today, do you have an idea when we get back down to that sustainable level?

[Ian Walsh, Chairman, President and Chief Executive Officer]

Yes. I think when we look at all the reports, there's clearly a very nice recovery that's happening on the commercial side, predominantly Boeing and Airbus for sure. We're seeing that across not just them, but also GA [ph], Motorcraft and even Business Aviation. So I feel very comfortable with the forecast that we've talked about before, where when you look at those end markets for us on the Engineered Products business, they're going to continue to be very strong.

As Jamie mentioned, as we mentioned last time, we started the year with record backlogs. Backlogs that, quite frankly, we achieved way earlier than normal. So really, we're focused on the execution piece for Engineered Products. We've got tons of opportunity to drive there across not just the traditional engineering products, but as we mentioned, even the aftermarket side of things.

[James Coogan]

And Jacob, I'll just add to that. I think there's probably still some room to run an above average growth for period, specifically as Boeing and Airbus start to get their build rates back to those more historical levels, right? We're still not at those historical build rate levels that we had in 2019. We talked in the past about some market share wins that we were able to make during the downturn, during COVID, which are not fully reflected in the historical results.

And when you look at traffic miles, we've all been to the airport, and airports are crazy busy, but the reality of the situation is we're still kind of below those sort of pre-COVID levels, all things being equal. So they're running older planes more and more. That benefits these kind of aftermarket components of our business. And we still have opportunity to see build rate increases and those market shares come in meaningfully to the top line performance.

[Jacob Moore, KeyBanc Capital Markets]

Okay. Great. That's helpful. And my last couple here, just on KARGO UAV. First, can you just give us an update on the timeline for the initial full-scale test flight?

[Ian Walsh, Chairman, President and Chief Executive Officer]

Yes, sure. So we, the team, continues to do a lot of work on the testing side of things as we get to first flight, which we're very, very close to. So for example, there's been a lot of static and dynamic testing.

We've had the whole full rotor system now fully tested. We just recently received FAA authorization to fly. Propulsion system and the autonomy package have all been tested. So we were hoping, obviously, as we talked about to have a first flight earlier in the year, but breaking ground is a big deal, a big milestone. So we are very, very close. We'll share that once we do.

And once we do break ground from a timeline and it's really full speed ahead to get to next year, which is the final fly off for the MOSAIC competition with the Marine Corps, which is the program of record that we're working with right now. And we've also got, like we said, orders from PHI. They're very excited about it. So that's the timeline. This is a big year for us. This is first flight for this year, and we're very, very close.

[Jacob Moore, KeyBanc Capital Markets]

Okay. Got it. That actually leads sort of into my second question here, which is, what the competitive environment looks like in that MOSAIC program. I'm really trying to get a sense for the amount of effort and dollars you'll have to commit over the -- to commit to continue being competitive for the next few years?

[Ian Walsh, Chairman, President and Chief Executive Officer]

Well, the MOSAIC program right now is us and one other competitor. The market space, there are others in the space mostly on the, say, commercial side, some on the early development side, a lot of it's kind of in electric mode.

We're a traditional turbine mode, the power plant. So -- on the committed dynamic, we anticipate the Marine Corps, and again, this is fluid relative to when we do a fly off next year. And when they down select and we honestly don't know if they're going to down select to just one, or they actually may select both, depending on how they want to go and what the competitor shows up with.

So that's good news for us. We feel like we're in a very strong position to win that relative to the maturity of our model and the approach we've taken with more off-the-shelf and proven parts and technology and things like that.

[Jacob Moore, KeyBanc Capital Markets]

Okay, got it. Thank you very much for taking my questions. That's all I have this morning.

[Ian Walsh, Chairman, President and Chief Executive Officer]

Great, thanks, Jacob.

[James Coogan]

Thanks Jacob.

[Operator]

[Operator Instructions] All right. I see no further questions at this time. I will turn the call back over to Jamie Ranno.

[James Ranno, Assistant Controller]

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.

[Operator]

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