Kaman Corporation
Q1 2018 Earnings Call Transcript

Published: 8 May 2018

[Operator:]

Good day ladies and gentlemen, and welcome to the Kaman Corporation First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference call is being recorded. Now like to turn the call over to Jamie Coogan, Vice President, Investor Relations. Sir, you may begin.

[Jamie Coogan:]

Good morning. I’d like to welcome everyone to Kaman’s first quarter 2018 earnings call. Conducting the call today are; Neal Keating, Chairman, President and Chief Executive Officer; and Rob Starr, Executive Vice President and Chief Financial Officer. Before we begin, I would like to note that some of the information discussed during the call will consist of forward-looking statements setting forth our current expectations with respect to the future of our business, the economy and other future events. These include projections of revenue, earnings and other financial items; statements on the plans and objectives of the company or its management; statements of future economic performance; and assumptions underlying these statements regarding the company and its business. The company’s actual results could differ materially from those indicated in any forward-looking statements due to many factors, the most important of which are described in the company’s latest filings with the Securities and Exchange Commission, including the company’s first quarterly report on Form 10-K and the current report on Form 8-K filed yesterday evening together with our earnings release. In addition, we expect to discuss certain financial measures and information that are non-GAAP measures as defined in applicable SEC rules and regulations. Reconciliations to the company’s GAAP measures are included in the earnings release filed with yesterday’s 8-K. With that, I’ll turn the call over to Neal Keating. Neal?

[Neal Keating:]

Thank you, Jamie. Good morning and thank you for joining us on today's call. I'd like to begin today with an update on each segment before I turn the call over to Rob to discuss our financial results and to review our updated outlook for the balance of 2018. Starting with distribution, sales growth in the first quarter has continued to improve with sales per day up 4.5% over the prior year and 4.6% sequentially. We saw increased sales in seven of our top 10 end markets led by machinery manufacturing, transportation, food, and mining. We were pleased to see a step up in sales volume across the business, especially in light of a relatively modest increase in sales from our national accounts. However, we have won several new national accounts which carried some near term costs as we onboard these new customers. Although it takes time to transition these accounts, we expect a slight benefit in the second quarter, which will then ramp up more significantly through the remainder of the year. Additionally, we saw a $12 million increase in our backlog and when coupled with our national account activity, this provides us a positive backdrop for the balance of the year and helps position us to drive continued revenue growth. Turning into aerospace, results for the quarter reflect strong performance on a number of our military and defense programs, offset by a decline in our commercial programs due to lower K-MAX sales and 777 structure sales as this legacy commercial platform transitions to the next generation design. We have been successful in securing applications on a number of new platforms that position aerospace for continued growth in 2019 and beyond. Moving to our largest program, we delivered over 3,900 JPFs in the quarter with approximately 3,600 of the deliveries associated with DCS contracts. We still expect to deliver between 34,000 to 38,000 fuses during 2018 with a significant portion of these deliveries going to satisfy our US government requirements. While, we've benefited from the favorable DCS mix in the quarter, the higher mix of US government sales for the full year will put modest pressure on aerospace operating margin performance. Interest for the JPF remains strong and we're in the process of negotiating new contracts that would significantly expand the order book for this product. During the past few years, we've made considerable investment in support of our specialty bearings and engineered product offerings. These investments in advanced machine tools, robotics and automation have allowed us to lower our production costs and reduce our lead times. And in 2018, we will open a new state-of-the-art test facility that will enable us to reduce our time to market while allowing our engineers to design and test new products for next generation applications and platforms. And over the past number of years, we have worked to expand our relationship with Airbus and have increased our content on a number of aircraft. Recently, we held a celebration on our Bloomfield campus in honor of our selection by Airbus, as a strategic technology partner, underscoring the capabilities we bring to our customers in helping them to meet their most challenging applications. We are proud to have been recognized by Airbus and look forward to continuing to expand this relationship. For our composite structures programs, we continue to make progress on the restructuring and transition steps we announced last year. Cost for these actions weighed on aerospace margin performance for the quarter and are expected to be weighted to the first half of the year. We expect benefits from these actions will increase as we move through the year reaching full rate, run rate in 2019. Driven by the successful execution of our most recent JPF contract, aerospace backlog grew to over $800 million at the end of the quarter. This high watermark for aerospace positions us well for the future by providing critical backlog and programs like the JPF, Black Hawk, AH-1Z K-MAX and across our specialty bearings and engineered product slides. Before passing the call off to Rob, I wanted to spend a moment talking about our acquisition strategy moving forward. The quarter saw a significant increase in cash flow compared to the prior year and when combined with our stronger cash flow generation in the latter half of 2017, we have significantly reduced our debt load, providing increased flexibility to execute on our acquisition strategy. We are evaluating potential targets focused largely on our aerospace business, which would enhance our engineer products offerings while leveraging our current capabilities to help drive synergies. As we move through this process, we will remain disciplined in our approach to valuation, mindful of our internal return on invested capital metrics. And now I'll turn the call over to Rob. Rob?

[Robert Starr:]

Thank you Neal and good morning everyone. I will begin today by touching on the change in revenue recognition accounting, which is reflective in our results for the quarter. Before moving to our performance and finishing with an update on our outlook for 2018. We adopted the new revenue recognition standard at the start of the year, and our first quarter results reflect the adoption of the new standard. With prior period results still accounted for under the old revenue standard. I would like to take a moment to discuss how this affects our results. For distribution, the method of revenue recognition remain substantially the same and the impact for the quarter was relatively immaterial. For aerospace, the impact was more significant. Prior to the adoption, we recognize revenue on a majority of our long-term contracts using units of delivery as a measurement basis. Generally speaking, this means that we recognized revenue upon the delivery of our products to our customers. Under the new revenue standard, we now recognize revenue on a majority of these contracts when costs are incurred as work progresses on a ,program prior to the delivery of the product to our customers. It is important to note that while the adoption of the new standard impacts the timing of revenue recognition, it does not affect the total amount of revenue we will recognize on these contracts or the timing of cash receipts or payments related to these contracts. So what does this mean moving forward? The programs with the largest impact on our results from this change are JPF USD program and our K-MAX program. Our JPF USD revenue recognition will be smoother quarter to quarter, as we recognize revenue as costs are incurred on this program. Eliminating the volatility that we often experienced in the past when revenue was recognized only upon delivery to our customer. Importantly, the new revenue recognition method better aligns with the economics of this program as we receive progress payments from the US government as cost is incurred. For the first quarter of this meant that we recognize revenue on our JPF Option 13 program, prior to delivery. For K-MAX, we will now recognize revenue upon transfer of title to our customer, moving away from a model where revenue was recognized as we've made progress on the aircraft prior to delivery. In the current quarter this meant lower K-MAX revenue as we recognize revenue on one aircraft delivery during the quarter. The increase in operating income associated with the adoption of the standard in the first quarter was 9.7 million which as noted above, is primarily related to timing. As a reminder, we prepared our 2018 outlook under the new standard and anticipated it would result in an increase in operating income for the year as highlighted on our fourth quarter call. Please refer to our Form 10-Q filed last season for a more detailed discussion related to the adoption of the new revenue recognition standard. With that said, let's move to the results for the quarter. Consolidated sales in the first quarter increased 6.3% to 463 million, as sales increase that both segments and benefited from favorable foreign currency exchange rates. Diluted earnings per share of $0.50 included the impact of restructuring and severance costs incurred in the quarter. When adjusted for these items, we achieved adjusted diluted earnings per share at $0.55 compared to $0.22 in the prior year. The increase in diluted earnings per share is the result of profit recognize on our JPF, Black Hawk and AH-1Z programs. Additionally, earnings for the period benefited from the significant reduction in our effective tax rate and the improved performance, we delivered on our pension plan. Aerospace sales increased 9.2$ to 179.4 million compared to 164.3 million in the prior year period. Sales for the quarter included a higher mix of JPF, DCS deliveries and an increase in USG JPF revenue as we began recognizing revenue under Option 13 of our USG contract. Additionally, we saw an increase in Specialty Bearing product sales, primarily related to higher volume for our miniature bearings and our PMA offerings. Operating margins for aerospace were 12.6% or 13.6% when adjusted for the 1.7 million of restructuring and severance expenses, a 380 basis point increase over the prior year. We expect improvement in aerospace margins as the contribution from our specialty bearing products increases in the second half of the year. At distribution our sales increase 4.5% to 283.9 million compared to 271.6 million in the prior year period. Daily sales for the quarter total, 4.4 million through 6 million per sales day a 4.5% increase over the prior year, representing our highest daily sales rates since the second quarter of 2016. We saw growth across all of our product platforms with the most notable increase coming from our bearings and power transmission products. First quarter operating margin performance of 4.2% was in line with our expectations. As is typical, the first quarter margins were disproportionately impacted by certain employee related costs such as payroll taxes to vacation and 401k expenses. The impact from these costs lessens through the year contributing to higher margins in subsequent quarters. Before I move to a discussion of our cash flow performance for the quarter, I want to touch on the change in the accounting for pension related income and expense. As discussed on the fourth quarter call, changes in the accounting for these items resulted in their reclassification of approximately 3 million of pension expense for the quarter below the calculation of operating income. This reclassification lowered operating margins for distribution in aerospace by approximately 30 basis points and 110 basis points respectively from what we would have disclosed under the prior accountant treatment. Absent, this accounting change, distribution would have delivered a 4.5% operating margin, while aerospace would have delivered an operating margin of 13.7% or 14.6%, when adjusted for the restructuring costs. Our cash flow from operations were 56.9 million compared to the prior year period use of cash at 18.5 million, a 75 million improvement. This led to free cash flow of 50.5 million, which we use to pay down debt, reducing our leverage ratio to two times the low end of our long term range. With the increased availability under our revolving credit agreement and the anticipated cash flow performance for the year, we have ample financing capacity to execute on our acquisition strategy. Moving to our outlook, we continue expect sales at aerospace to be in the range of 750 million to 780 million with operating margins of 15.5% to 16.0% or 16.2% to 16.75, when adjusted for the approximately 5.5 million of restructuring and transition cost. We are increasing our expectations for distribution sales by 10 million for the year due to the anticipated ramping sales from national accounts. We now expect sales in the range of 1.11 billion to 1.6 billion with operating margins in the range of 5.1% to 5.4% We are increasing our expectations for income from our defined benefit our pension plan by 1 million to 12.5 million, as assumptions underlying the previous calculation had been finalized. In April, we announced 2.6 million in one time employee incentives. This expense was not previously contemplated in our prior 2018 outlook. Despite this, the performance of the segments in the first quarter provides us confidence to hold our prior expectations for operating margin, effectively raising our expectations for the underlying performance of our segments for the year. In addition, we elected to contribute an additional 10 million to our pension plan, which will receive a tax benefit our 2017 effective tax rate. Taking this additional contribution into consideration, we are still maintaining our expectations for cash flow from operations at $185 million to 210 million or free cash flow of $150 million to 175 million. As we mentioned last quarter over the last four years, our free cash flow conversion has averaged 127% percent well above our long term goal of 80% to 100% of net earnings. We expect this to continue through the balance of 2018. Moving into the cadence of earnings for the year, we still expect approximately 70% of our earnings in the second half of the year. With that, I'll turn the call back over to Neal.

[Neal Keating:]

Thank Rob. I'd like to thank our investors for their interest in support as well as the dedication and commitment of our more than 5,300 employees for delivering world-class products and services to our customers every day. Now I'll turn the call back over to Jamie. Jamie?

[Jamie Coogan:]

Operator, can we have the first question, please?

[Operator:]

[Operator Instructions] And our first question is from Edward Marshall with Sidoti & Company.

[Edward Marshall:]

Morning guys, how are you?

[Neal Keating:]

Good. Ed, how are you doing?

[Edward Marshall:]

I'm okay. Thanks. So with the other option of 606 and then the JPF timing, the smoothing, I'm curious why is still the 70/30 split through the remainder of the year? Is there something specifically wearing on the margin in 2Q or is the rest of that large -- and secondly, is that rest of that large DCS order, was that shipped in Q1?

[Robert Starr:]

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

[Edward Marshall:]

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

[Neal Keating:]

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

[Edward Marshall:]

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

[Robert Starr:]

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

[Edward Marshall:]

Final one for me, how you managing freight inflation?

[Robert Starr:]

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

[Edward Marshall:]

Got It. Thanks guys very much. Appreciate it.

[Robert Starr:]

Thank you, Ed.

[Neal Keating:]

Thank you, Ed.

[Operator:]

Thank you. Our next question comes from Pete Skibitski with Drexel Hamilton. Your line is open.

[Pete Skibitski:]

Good morning guys.

[Robert Starr:]

Good morning, Pete.

[Neal Keating:]

Good morning, Pete.

[Pete Skibitski:]

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

[Robert Starr:]

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

[Pete Skibitski:]

So it feels better to you than it has in several years because obviously it's been an, you know, it's been awhile since distribution had a real topline organic story going for it?

[Robert Starr:]

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

[Pete Skibitski:]

Okay. I just want to ask on the JP side, you've booked a $324 million order and yet you're still saying that there's more significant new opportunities, which is a nice statements there. I thought a, given what just happened. So any color? I know it's probably some sense of to some degree, but anything you can add in terms of timing of these types of new orders and relative sizing?

[Robert Starr:]

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

[Pete Skibitski:]

That's great. That's great. Thanks guys. I'll get back in queue.

[Robert Starr:]

Thanks Pete.

[Operator:]

Thank you. Our next question is from Ryan Cieslak with Northcoast Research.

[Ryan Cieslak:]

Hey, good morning guys.

[Robert Starr:]

Morning Ryan.

[Ryan Cieslak:]

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

[Robert Starr:]

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

[Ryan Cieslak:]

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

[Neal Keating:]

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

[Ryan Cieslak:]

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

[Neal Keating:]

They do, that’s right.

[Ryan Cieslak:]

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

[Neal Keating:]

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

[Ryan Cieslak:]

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

[Neal Keating:]

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

[Ryan Cieslak:]

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

[Robert Starr:]

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

[Ryan Cieslak:]

Okay. So maybe there's something there's some conservatism all baked into your thinking about the second quarter plays out and relative to the rest of the year as well?

[Robert Starr:]

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

[Ryan Cieslak:]

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

[Neal Keating:]

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

[Ryan Cieslak:]

Okay, great. Thanks a lot guys.

[Operator:]

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

[Neal Keating:]

Morning Steve.

[Steve Barger:]

Were the national account conquests wins over other national distributors or from the local market competitors? And what really drove that win?

[Neal Keating:]

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

[Steve Barger:]

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

[Neal Keating:]

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

[Steve Barger:]

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

[Robert Starr:]

Sure. Steve, in terms of the onboarding cost that we took on this first quarter, about a 10 basis point impact during the quarter.

[Steve Barger:]

Okay.

[Robert Starr:]

And then, in terms of the margin that we would expect, these national accounts are going to be pretty much roughly in line with what we would normally expect a across our national account portfolio. So, certainly largely speaking, we just take a bit of a lower margin in terms of the contracted rate, but we do benefit a given the volumes to rebate and other areas. And these are strategic accounts that allow us, as Neil mentioned to also provide a differentiated service across all three product platform. So it's, it's a really good growth opportunity for us.

[Steve Barger:]

Sure. Well, yeah. And to that point, I think you had said the national side of lower year over year growth rate in the quarter. Why do you think they start to contribute more in the back half or 2Q and do you see more growth opportunity with the bigger customers going through the rest of the year? Or just in, in writing the cycle with the smaller customers? I'm just trying to think about how we're outgrows comes from?

[Robert Starr:]

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

[Neal Keating:]

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

[Steve Barger:]

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

[Neal Keating:]

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

[Steve Barger:]

That's very good. Thank you.

[Neal Keating:]

Thank you Steve.

[Operator:]

Thank you. Our next question comes from Chris Dankert with Longbow Research.

[Chris Dankert:]

Good morning guys. So now looking at the KIT in the past, you've been looking to kind of optimize the margin profile there through pruning. I guess was there any meaningful pruning impact on the first core that you'd call out?

[Robert Starr:]

I don't think that there is Chris.

[Chris Dankert:]

Okay. But then I guess, apologies if I missed it, but as far as the K-MAX goes, did you guys officially ship those three units in March or did any of those kind of slip into in April? Here is the plan still six units being shipped for the years?

[Neal Keating:]

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

[Chris Dankert:]

I guess thinking about came, I actually want to get any other demonstrations, marketing events and there's a big kind of pushes coming up here since we have a little bit of downtime on the fire season?

[Neal Keating:]

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

[Chris Dankert:]

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

[Neal Keating:]

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

[Chris Dankert:]

Sounds good. Thanks so much guys.

[Neal Keating:]

Okay, thanks Chris.

[Operator:]

Thank you. [Operator Instructions] And we have a follow up from the line of Pete Skibitski with Drexel Hamilton.

[Pete Skibitski:]

Yeah guys, the Q I think talks about lower gross margin in aerospace bearings. I'm just wondering is it materials, you know, steel, aluminum or if it's volume pricing or if it's just temporary issue, just wonder if you could expand on that?

[Robert Starr:]

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

[Pete Skibitski:]

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

[Robert Starr:]

Yeah, a couple of things, first, that impact Pete will really be split between the second and third quarters. So there was no impact in the first quarter relating to the employee incentive.

[Pete Skibitski:]

I see. Okay.

[Robert Starr:]

And then, rough order of magnitude, it's roughly 50/50 between aerospace and distribution.

[Pete Skibitski:]

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

[Robert Starr:]

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

[Pete Skibitski:]

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

[Neal Keating:]

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

[Pete Skibitski:]

That's great. Appreciate it guys.

[Neal Keating:]

Okay. Thanks Pete.

[Operator:]

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

[Ryan Cieslak:]

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

[Robert Starr:]

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

[Ryan Cieslak:]

Okay, great. And then my last one is just any update you can provide on the implementation of the ERP within distribution of that spend delayed. Is this something you guys plan to start to kick started again here in the back half of the year or how do we think about the time you did that going forward? Thanks.

[Robert Starr:]

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

[Ryan Cieslak:]

I am okay. Thank you.

[Operator:]

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

[Jamie Coogan:]

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

[Operator:]

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