Kaman Management Discusses Q3 2013 Results - Earnings Call Transcript

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Kaman (NASDAQ:KAMN) Q3 2013 Earnings Call October 29, 2013 8:30 AM ET

Executives

Eric B. Remington - Vice President of Investor Relations

Neal J. Keating - Chairman, Chief Executive Officer and President

Robert D. Starr - Chief Financial Officer and Senior Vice President

Analysts

Arnold Ursaner - CJS Securities, Inc.

Matt Duncan - Stephens Inc., Research Division

Edward Marshall - Sidoti & Company, LLC

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Stephen E. Levenson - Stifel, Nicolaus & Co., Inc., Research Division

Eli S. Lustgarten - Longbow Research LLC

Bhupender Bohra - Jefferies LLC, Research Division

Operator

[Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I will now like to turn the presentation over to Mr. Eric Remington, Vice President of Investor Relations. Please proceed.

Eric B. Remington

Good morning. Welcome to the Kaman Corporation Third Quarter 2013 Conference Call to discuss our earnings results. Conducting the call today are Neal Keating, Chairman, President, Chief Executive Officer; and Rob Starr, Senior Vice President and Chief Financial Officer.

Before we begin this morning, 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 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 2012 annual report on Form 10-K and the current report on Form 8-K filed yesterday evening together with our earnings release.

With that, I'll turn the call over to Neal Keating. Neal?

Neal J. Keating

Thank you, Eric. Good morning, and thank you for joining us today. Overall, we are pleased with the results achieved by our operations during the third quarter, resulting in diluted earnings per share of $0.70 and diluted earnings per share from continuing operations of $0.68.

Aerospace delivered strong results with improved contributions across many of our product lines, while Distribution operating margins increased over the prior year and sequentially as we continue to drive improved profitability despite lower than expected organic sales levels.

Starting with Aerospace. Sales from the quarter was slightly below our expectations, primarily as a result of delay initial AH-1Z deliveries. This deferral was partially offset by a number of customer quested pull-ins to meet their scheduled demands. Operating margin in the quarter was 18.3%, 220 basis points higher than the prior year, driven by higher fusing margins, higher bearing sales and increased profit across other product lines.

The segment benefited particularly from our SH-2 helicopter programs, including the New Zealand SH-2G(NYSE:I), legacy New Zealand SH-2G spares and Egyptian SH-2 maintenance and upgrade programs. All of which delivered outstanding performance. Sequentially, the Aerospace operating margin improved by 50 basis points, highlighting the strength and diversity of our programs across the segment.

We started the year with strong first half performance in Aerospace led by Specialty Bearing product lines, which benefited from several onetime retrofit and upgrade programs that are not related to current aircraft production. As a result of this spike in sales in the first half of the year, bearing revenues declined as expected by approximately 10% sequentially in the third quarter. However, the core bearings revenues continue to grow, and we remain confident in the performance of the business.

In addition, the higher Aerospace operating margin performance during the quarter reflects meaningful improvement across our other product lines.

In the quarter, we delivered approximately 4,200 JPF fuzes, a majority of which were direct commercial sales to a foreign government. Our third quarter shipments were in line with our plans, this compares to deliveries of more than 10,000 fuzes in the third quarter of 2012. The BLACK HAWK program continues its steady performance, and we were pleased to recently achieve the milestone 1,000 cockpit delivery to Sikorsky. We are about 1 year into our latest multiyear BLACK HAWK contract and expected to remain one of our largest programs.

And our newest program, the SH-2G(I) for New Zealand is ramping up nicely and is on time and on budget at this stage.

As highlighted in past calls, our Aerospace group has many programs that are in various stages of development. The scope of new programs is unprecedented in our history. Programs of note include the AH-1Z for Bell, Learjet 85 and the Gulf Stream G280. I am pleased to report that we successfully finalized delivery of the first AH-1Z cabin earlier this month and anticipate completing delivery of 2 additional aircraft before the end of the year. As we reached rate production on these and other programs, we expect them to contribute towards our increased profit and improved cash flow.

Overall, Aerospace is firmly positioned to continue to improve operational performance, ramp up new programs and win additional work to provide steady long-term growth.

Distribution sales were a quarterly record of $273 million, up 5.7% over 2012. Organic sales per day were down 1.2% in the quarter, driven by lower sales from our bearing and power transmission customers. Our OEM customers continue to be negatively impacted by difficult global market conditions. And in addition, several of our MRO end markets have not rebounded as strongly as we had anticipated at the time of our last call.

As we highlighted during our second quarter call, we expected year-over-year sales growth to tip positive during the third quarter, and despite the challenging conditions, we did achieve positive sales growth in September, which represents our first month of positive year-over-year growth in 13 months and our highest month of year-over-year growth since January of 2012. And remember, this performance was against a difficult cap as sales in the third quarter of 2012 were up 10.1% over 2011.

We experienced strong MRO demand in transportation equipment, nonmetallic mineral manufacturing and chemical manufacturing. The flat sales in mining, which was an improvement over recent quarters. This strong demand was offset by weakness in the paper manufacturing and OEM markets. And during the quarter, we also experienced sharply lower sales in Mexico due to a drop in project-related volume from certain mining customers, which negatively impacted profitability. However, our electrical and automation platform has performed well, and our acquisition sales in these area have exceeded our expectations.

Distribution sales growth has been slower than we anticipated, but as we move into the final quarter of the year, we expect additional growth from acquisitions and modestly positive organic sales growth trends as the economy continues its slow recovery. Overall, we are well-positioned to benefit from a sales recovery in Distribution by capitalizing on our 3-platform strategy, which enables us to provide exceptional value of proposition to our customers. Now, I would like to turn it over to Rob Starr to provide you with some additional details and color. Rob?

Robert D. Starr

Thank you, Neal, and good morning, everyone. As Neal indicated, we are pleased with our results for the third quarter, which produced a 26% increase in consolidated operating profit on 3.5% higher sales as compared with the third quarter of 2012. These results demonstrate our discipline on expenses, the operating leverage inherent in our businesses and the benefit of our diversified product portfolio.

Now I'd like to provide you with some additional color on the numbers and our expectations.

Within Aerospace, we delivered solid execution across the segment. While we expect our operational performance to remain strong, we anticipate our future product mix will change somewhat. As we move forward, our expectation for sales of Aerospace built-to-print work to ramp up as we enter into full rate production on a number of our startup programs, Neal had referenced earlier. These programs which tend to generate a low return on sales and segment average will play some downward pressure on our overall Aerospace operating margin percentage. These programs, despite having lower margins, provide earnings accretion, cash generation and a solid return on investment.

In Aerospace, our backlog remains solid ending the quarter at $656 million, an increase of 22% since year end. Recent significant bookings include the SH-2G(I) contract and several JPF awards. We have also booked awards of numerous smaller programs, such as Baron[ph] programs, the P-8 and ch-47 for Boeing.

Distribution recorded an operating margin of 5.4% in the third quarter, representing improvement sequentially and over the prior year. Profit improvement was broad-based as a result of leverage from our higher sales, pushing our record in September, continued operating leverage as a result of our Q1 restructuring efforts.

We're also achieving early benefits from our diversification efforts in our 3-platform strategy as evidenced by our strong performance in the quarter from our electrical and automation product lines. Margin also benefited from the reduction of certain incentive accruals. Offsetting some of these improvements were issues with Mexican mining projects and pressure on inter[ph] volume incentives.

Our free cash flow generation has been strong, generating $41 million in the last 2 quarters even after spending $80 million in capital expenditures. The organization is focused on improving cash flow and we've taken a number of actions to ensure we meet our objectives.

Moving on to our outlook, we are revising our estimates to reflect our current view of the business environment. At Distribution, while growth rates are improving, they are not achieving the levels we expected when we last spoke. This has caused us to temper our full year sales outlook, relative [indiscernible] outlook sales levels will negatively impact our operating leverage and we'll lower volume incentives from our suppliers.

At Aerospace, we have slightly lowered and narrowed our sales estimates to reflect our current view of the business environment. This reflects our routine shifts and the timing of deliveries and revenue recognition. The operating margin outlook has been raised to a range of 16.8% to 17%, reflecting stronger than expected year-to-date margin performance, which we anticipate will be sustained.

As we refine our estimates for the full year, we now expect corporate expenses to come in below our original estimates. We are projecting our full year tax rate will also be lower than previously anticipated at 34.5%, reflecting a lower statutory rate in the U.K. and favorable items from our filings of our 2012 return this past September.

We are maintaining our full year free cash flow outlook at $15 million to $20 million. This reflects our expectations for continued investments in capital expenditures across the company and working capital for new Aerospace programs.

Overall, we are pleased with our results to-date, and we are focused on delivering stronger results. With that, I'll turn it back over to Neal. Neal?

Neal J. Keating

Thanks, Rob. Overall, we delivered strong results from the third quarter. We have benefited from a successful execution of our strategies across our segments and remain confident that we will continue to deliver improved operational performance. I would also like to take this opportunity to thank all of Kaman's employees for their hard work and dedication. Their efforts have enabled Kaman to reach this new level of performance.

With that, I'll turn the call back over to Eric. Eric?

Eric B. Remington

Thanks, Neal. Operator, may we have the first question, please?

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from the line of Arnie Ursaner from TJS (sic)[CJS] Securities.

Arnold Ursaner - CJS Securities, Inc.

My question relates to the impact of the SH-2G program on your margin and revenue in the quarter. You did indicate it was somewhat a key contributor. Can you quantify the impact of that for us? And remind us if it will have an impact in Q4?

Robert D. Starr

Sure, hi, Arnie, it's Rob. The SH-2 did have a slightly above segment average impact. As we mentioned, we are expected to deliver on $20 million of revenue on that program for the year, and we remain on track to deliver that. So I think it's about, roughly about 4 or 5 points higher than our segment average.

Arnold Ursaner - CJS Securities, Inc.

How much was the revenue contribution in Q3 of the $20 million?

Robert D. Starr

Sure. It was approximately $5 million for the quarter.

Arnold Ursaner - CJS Securities, Inc.

So you expect the similar amount in Q4?

Robert D. Starr

Similar. Maybe slightly more in Q4, but not much.

Arnold Ursaner - CJS Securities, Inc.

And a similar margin?

Robert D. Starr

Yes.

Arnold Ursaner - CJS Securities, Inc.

Okay. And Rob, I know when you spend some time with me, you try to highlight some of the working capital impacts when you start up new programs and you did mention the AH-1Z is about to be -- actually at its first delivery early this month. So as we think about Q4, can you just remind us of the capital investment you make when you have a new program running forward? And how that may change now that this is moving into a full program?

Robert D. Starr

Sure. I would highlight a couple of things here, Arnie. You're absolutely right. In particular, AH-1Z, we have invested significantly in startup working capital. And with the delivery of our first cabin in the fourth quarter, we would expect to see some relief in our working capital related specifically to that program. But it's not going to be all that material in the fourth quarter and largely because we are ramping up a number of other production units. We expect to deliver, hopefully, another 2 units in the fourth quarter. But as we enter full rate production, as we consistently generate cash flow relating to the sales, we would expect over the course of the next, let's call it 6 to 12 months, to see some meaningful reduction in our AH-1Z inventory.

Operator

[Operator Instructions] Next question is from the line of Matt Duncan from Stephens Incorporated.

Matt Duncan - Stephens Inc., Research Division

First question I got with regard to the trends you're seeing at KIT. I know you touched on this, you said that those sales flipped into positive territory on an organic basis in September. Could you maybe walk us through the month-to-month growth rates that you saw there? How much was September up? And what are you seeing in October?

Robert D. Starr

Sure. Matt. It's actually a really good question. Because as you remember, during our last call, we were actually seeing some positive trends in July. However, after the call, that turned down and August was bad as well. In fact, we were a little bit more than 5% negative organic growth in both July and in August. That turned around where we were positive 5% in September, which we were really pleased with. We don't have final numbers yet for October, but to-date, we are running between 3% and 4% positive.

Matt Duncan - Stephens Inc., Research Division

Okay. And did the comp get easier there in September, Neal? Or was that your actual demand and volume improvement? Or was it a little bit of both?

Neal J. Keating

I think it was a little bit of both.

Robert D. Starr

Matt, it was a bit of both in September.

Matt Duncan - Stephens Inc., Research Division

Rob, on the SG&A cost, they were down about $3 million sequentially. You mentioned that there was some benefit in the quarter on variable comp accruals. Did you actually reverse some accruals from earlier in the year or did the amount of the comp accrual just go down?

Robert D. Starr

As we -- just our full year outlook, we did make some downward estimates in terms of our overall incentive comp numbers.

Matt Duncan - Stephens Inc., Research Division

How much they did that reversal lower your SG&A expense by in the quarter?

Robert D. Starr

I would say that was a portion of the reduction. I mean, there are other expense control initiatives in place as well, Matt.

Matt Duncan - Stephens Inc., Research Division

Sure, but just on that one item, do you know off the top of your head how much it was?

Robert D. Starr

Yes. I mean, I would say, it was not all of it but it's certainly a meaningful percentage of that reduction.

Matt Duncan - Stephens Inc., Research Division

Okay. So call it $2 million or so of the sequential drop in SG&A?

Robert D. Starr

I mean, I'm really not....

Matt Duncan - Stephens Inc., Research Division

Is that fair?

Robert D. Starr

It's not unfair but I think it's one of those estimates that's going to change as we go through the rest of the year, as we look through the full year number. But yes, in the third quarter, that's not an unfair estimate.

Matt Duncan - Stephens Inc., Research Division

Okay. One more and I'll hop back in queue. In terms of the operating margin at your Aerospace segment, it's obviously been bouncing around a lot. And if I look at your guidance for the full year it implies it's going to be probably 15.5%, give or take. In the fourth quarter, it's going to be 16.8% to 17% for the full year. Could you give us some help as we look out to next year, once these programs ramp up and the mix sort of settles in for that segment where you think it's going to be, what type of operating margins should we be using for that segment? I know you haven't given guidance for next year yet, but given how much the margins been moving around there, I think there's a lot of questions about sort of where that margin's headed in the future.

Robert D. Starr

Matt, we -- I guess I'd start by saying we've set an objective for the Aerospace segment of upper teens operating margins. And over time that's a range we're comfortable with. You're exactly right. We've had some bouncing around this year, driven by a couple of factors. It's primarily been deferrals or later shipments in the year than we'd anticipated on AH-1Z and some of the other startups programs that, as Rob said in his prepared comments, are built-to-print work with lower margins. So as those have moved out into the fourth quarter now, and also we've had some pull-ins by other customers for our Specialty Bearing product lines and actually some of the Egyptian helicopter upgrade program as well, which are at higher margins. That's really exacerbated that switch from quarter-to-quarter in margins that you see, especially from the third quarter going into the fourth quarter. But I think we're comfortable with the high-teens operating margin in that operating segment.

Matt Duncan - Stephens Inc., Research Division

So 17% to 19% would be how you would define high-teens then?

Neal J. Keating

Sometimes, we go 16.5%, but that's probably not a bad range, Matt. I'll go check your model.

Operator

Next question is from the line of Edward Marshall from Sidoti & Company.

Edward Marshall - Sidoti & Company, LLC

Just 2 quick questions. One, I wanted to kind of get your opinion and maybe your outlook on how any kind of defense sequestration, et cetera, and not necessarily on the programs because I think you've covered that before, but more importantly on how the cash flow outlook kind of works with that. I assume your terms was slow just a bit, just kind of, maybe how you guys might be preparing for any kind of slow down there?

Neal J. Keating

I'll let Rob chime in. I don't think that sequestration is going to impact us as much from a cash flow perspective where we were more concerned about that, actually Ed, was with the furloughs of government workers where the people weren't at work to actually pay the bills. And that was -- that turned out not to be a problem for us because it was a relatively short timeframe. But we had DCMA inspectors that were not coming into the plant to sign off the final deliveries, for example, for either a Z or for UH-60. And then DFIS, which is the funding source out of the government, the office is actually pays the bills. They were on furlough as well. So I don't think sequestration will be as much an impact from a cash flow other than the program impacts that we talked about.

Robert D. Starr

Yes, I would concur with that. A couple of things. We are taking a number of very specific actions across our Aerospace units, in particular, at managing inventory levels relative to the demand. And part of the reason we generated quite a bit of cash flow in the back years, is a number of those initiatives are beginning to take effect. And in terms of sequestration, in terms of some of the startup programs, that's where we were our cash flow challenges has been really more on the startup program than specifically related to sequestration.

Edward Marshall - Sidoti & Company, LLC

The furloughs have any type of impact or push out push to the right in the third quarter?

Neal J. Keating

They did not in the third quarter, because that really happened Ed, on October 1st. We did have some slowdowns in the first couple of weeks of October. Right now, we're hoping to be able to make that up in the quarter. But a lot will depend on our end customers as to whether or not they're able to receive equipment from us, because we just don't know how much their lines have been backed up since they didn't have DCMA in for inspections.

Edward Marshall - Sidoti & Company, LLC

And then as we look kind of at the pension rolling into 2014, obviously, there's going to be some adjustments there with the change in rates. Any -- would you care to take a stab at it, as to what kind of benefit or tailwind you may receive from the pension?

Neal J. Keating

Sure. We're certainly benefiting from the higher discount rates, Ed. But what I would also point out is our investment strategy on our pension does incorporate what's known as a liability-driven investment strategy. So relative to some of your traditional investment strategies, your normal 60/40, we're not going to see as much benefit as a traditional 60/40. But I would expect to see our pension expense come down next year, probably somewhere in the range of 20% to 25%.

Edward Marshall - Sidoti & Company, LLC

What's that expense number this year?

Robert D. Starr

Actually, $8 million.

Operator

Next question from the line of Jeff Hammond from KeyBanc Capital Markets.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

I know you're not giving '14 guidance but you tend to have better visibility into the Aerospace business. Can you just talk about what you see as some key puts and takes, whether it be programs or just trends in commercial, military, as you look into '14? And then coming back to the margin comment, I just want to be clear if these ramp issues are 4Q issue or a 2014 issue as well?

Neal J. Keating

Okay. I'll start with that one, Jeff. We'll break it down into maybe 3 component parts, from the Aerospace side on the aircraft to begin with. Now commercial, we still see as strong through next year. Now I think that we've seen the first couple of steps of the 787 ramp up. So I would expect that we're not going to see within our Specialty Bearings business a big tick up from 787 next year. I think they're at the rate level now. Now late in '14, we might, or in '15 as they ramp up to now what they're saying it's going to be 12 aircraft a month. I think we see 787 as relatively consistent from year-to-year pickup hopefully with A350 later in the year, but that would be later in the year. And I think that, that kind of sums up another strong, slight growth in the commercial aircraft until A350 kind of hits its stride out into '15. Business Aircraft, we frankly still see as depressed, and we would love to see that tick back, but we don't see that yet. And then on the military aircraft side, without getting too program specific, I think we all know C-17 is going to come to an end. We have deliveries that will take us through mid-to-late '14 so we don't see much impact from that on '14. We might be flattish on UH-60, probably no growth there, but AH-60 ticking up. And maybe slight growth in A-10. But that's really how we see the markets kind of sizing up for next year. And then on the ramp, I guess the one other thing we'll see SH-2G(I) tick up for us next year. We'll tell you what that's going to be on our next call. But we'll obviously see that tick up. And then finally, on your question about the ramp rate. Obviously, fourth quarter we're going to have early deliveries, lower than segment margins. We'd expect that those early deliveries probably through '14 are going to continue at those lower margin contribution rates until we get to full rate production, probably in '15. But we'll talk more about at the next call.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

And then just one more, maybe just touch on how you're thinking about JPF and visibility on the same lines into '14 and maybe customer mix?

Neal J. Keating

Right now, we have more than 1 year of backlog so we feel good about that. I think it's just over $130 million. So we're good there. We would expect that we will have a much higher mix of USG sales next year. As you know, we've had high percentage of direct commercial sales that are very profitable for us this year. That's what has enabled us to stay constant or approximately constant in the profit contribution from that product line despite much lower unit volume from year-to-year. But we'll probably go back towards a more normalized trend of much higher percentage of USG sales.

Operator

Next question is from the line of Steve Levenson from Stifel.

Stephen E. Levenson - Stifel, Nicolaus & Co., Inc., Research Division

Neal, you mentioned that some new Aerospace programs you're hitting unprecedentive levels. I know one of your press releases was about the Scorpion. And I was just going to ask you to comment on what you think the opportunity is there? And what the risks are, given that it's a new plane and there basically aren't any orders for it? And how you decided to go into that and if there any other comparable ones or the other ones are different? I'm sorry, multipart question.

Neal J. Keating

That's okay. First of all, I give enormous credit to Textran for going off and taking this on. I think we all know that there's -- other than this aircraft, which people didn't know about, there's really no manned fighter aircraft or manned aircraft under development by the U.S. Department of Defense since first time since it was established. So I give Textran an enormous amount of credit in stepping out and taking on this development. I think the way they've done it has been very thoughtful as well. And I think that's what really drove us to team with them. We think Scott, Donald and his team are very, very smart guys, frankly. They saw an opportunity to put an aircraft out in the market that meets the needs for a broad range of missions and is going to be very cost effective. Certainly, there's risks. We've teamed with them on this program. We feel that it provides an opportunity, and we are going to do everything we can to help them be successful.

Stephen E. Levenson - Stifel, Nicolaus & Co., Inc., Research Division

And are there other programs that you didn't or haven't been named yet, maybe you can't name them, are they similar to this or they more along the lines, of say, AH-1Z where there is demand for the product?

Neal J. Keating

Steve, I'm afraid, I'm not clear on that part of the question.

Stephen E. Levenson - Stifel, Nicolaus & Co., Inc., Research Division

Are the other programs that are you involved in among the unprecedented number of new programs you're working on, more similar to Scorpion or more similar to other aircraft?

Neal J. Keating

No. More similar to-- I'm sorry, more similar to the named aircraft that are out in the domain today. The big ones for us are -- the biggest by far is the AH-1Z for Bell and another Textran & company. And we have -- I'll be down there again on Thursday of this week, but we got about 8 aircraft in process right now and certainly in our detail fab shop well past probably aircraft 12. So that's the buildup of inventory there. And then also, on Lear 85 and the G280, those are the main new startup programs that we're on, we're investing on but are going to do very well for us through '14 and '15.

Operator

Next question is from the line of Eli Lustgarten from Longbow Securities.

Eli S. Lustgarten - Longbow Research LLC

I have one just follow-up on Aerospace. During your commentary, you talked about first half of this year having some Specialty Bearings business, I believe, that helped profitability and then you also talked about some direct sales on the Aerospace programs that also helped profitability. I mean, the 2 factors suggested that we could have some difficult comps in 2014 versus '13 in the Aerospace profitability, at least in the first half versus first half if not for the whole year. Can you give us some color on how we should think about it if we go through -- if we look out into '14?

Neal J. Keating

I think that, Eli, you're right. We will have some tough comparative periods. The mix that we've talked about there is that in 2013, we had lower USG demand and therefore, much higher -- and much higher direct commercial sales of our JPF product line, and we do sell at higher prices for direct commercial sales. So yes, that will provide some headwind as we look at '14 versus '13. And also, we did have a number of retrofit and other programs in our Specialty Bearings product lines for things like helicopter drive shafts and other things that happened to land in the first half of the year as well. So we will have some tough comps. We have a business that's growing. We continue to make operational improvements, so we'll deal with those tougher comps.

Eli S. Lustgarten - Longbow Research LLC

So I mean, expectations that you still have improved profitability in '14 versus '13 even despite these headwinds?

Neal J. Keating

I think we're still refining our 2014 numbers, Eli. So we'll certainly address that on our next call.

Eli S. Lustgarten - Longbow Research LLC

Okay. Can we talk a little bit about what's going on in the Distribution business. OEM, as you say, was a very weak. Could you give us some idea whether inventory destocking or restocking, what's going on across the board by your customers? Are they finally starting to normalize their holdings? And can you give us some insight as to what you're seeing in the fourth quarter? I mean, after the shock we got out of the Timken numbers in the bearing and power transmission numbers, nobody's quite sure what's going on in the marketplace.

Neal J. Keating

I think what we're seeing with our OEM customer base is certainly a reevaluation of global market conditions. I mean, if you look at Caterpillar's numbers, certainly Timken is being affected by that. And we're seeing that in our direct OEM customer base, a softening. There's no question. In terms of -- could you repeat the second part of your question, Eli?

Eli S. Lustgarten - Longbow Research LLC

I'm just trying to get an idea of what you're seeing as you go to the end of the year, across the end market as I said, because the implication of the Timken numbers were things are getting much softer of course almost all about bearing and power transition markets, you show us a little bit different characteristics with the strength of that non-OEM business. I'm just trying to get a sense of what you're seeing in the fourth quarter from your end markets in the bearing business.

Neal J. Keating

Actually, specific to the Timken comment, if you look at our bearing product lines sales they're down but they are down low single digits, so not as much as a number of the OEMs have talked about. And actually, as we look at our market sequentially, Eli, of our top 10 markets, 6 were up and 4 were down so that was actually an improvement for us from our first to second quarter mix. So we're getting a little bit of underlying improvement. Actually, mining for us was up fractionally so that was a nice change for us. Primary metals were up. Transportations were up. The areas that were down for us were OEM machinery and more so in our traditional power transmission and motion control product lines. We had a very strong performance for OEMs in our electrical and automation platform. Paper is down for us quite a bit. Fabricated metals are down for us as well. But the other thing that we highlighted in our prepared remarks, Eli, is that we've had a significant amount of weakness in our Mexican operations. And also, we entered into a number of fixed price mining contracts. And quite frankly, we were not as experienced as we are today in those, from either how we bid them or from a project management perspective. So we are in the learning curve, if I can be kind there, and that's impacting us as well in the third quarter, and we expect some negative impact in the fourth quarter.

Robert D. Starr

And, Eli, just one other point I would like to make in terms of the overall reduction in our sales guidance for Distribution. That really does reflect the softer economy than we had anticipated during our second quarter call, consistent with what you're seeing whether it be from Timken or others that we've announced.

Operator

[Operator Instructions] Next question is from the line of Bhupender Bohra from Jefferies.

Bhupender Bohra - Jefferies LLC, Research Division

For Scott Graham here. The first question on Industrial Distribution, we are seeing, like you mentioned, September was up kind of mid-single digit. And then if I look at the guidance, actually, it kind of tells me the operating margin guidance was taken down so that kind of implies like 4Q guidance was, on the margin side for Distribution business, is low. Could you tell us what is driving that?

Robert D. Starr

Sure. Certainly, there are a few key items that are driving our reduced outlook for margin in the fourth quarter. In particular, to what Neal just commented on, the challenges that we're having in Mexico, that will have an impact on the fourth quarter as we're looking to close out those mining contracts. There was also increased pressure on vendor rebates as we are managing our cash flow correctly in lower sales volume, that will put additional pressure relating to that. And we're also just being a little bit cautious given the economic shut down -- I'm sorry, the government shutdown, excuse me, during October and what impact it might have on the broader economy. So a combination of those factors is really what's driving our margin guidance down.

Bhupender Bohra - Jefferies LLC, Research Division

Okay. How big is the Mexico mining thing, I mean is that like a big factor in terms of sales or margin wise?

Robert D. Starr

The impact is more on the margin side. As Neal mentioned, we were somewhat inexperienced in bidding out these contracts. So I'm really not at liberty to say how much the impact is, but it's certainly enough to make comment here on the call.

Bhupender Bohra - Jefferies LLC, Research Division

Okay. And the next question is on the same line basically. You guys talked about the 3-tier structure on the 3 platforms, basically, in KIT. Could you just elaborate like how those 3 platforms did actually performed during the quarter? If you can just give us some color on that?

Neal J. Keating

Sure. At a very top level Bhupender, the primary weakness that we had was in our legacy power transmission motion control product lines, and I think that's very consistent with what you would've seen both from other comparable distribution companies or certainly from the bearing and power transmission manufacturers that have reported as well. And I think we're very pleased with the progress we've made, both in our fluid product lines, as well as our electrical and automation product lines. That's really what enabled us to flip over to positive growth in September.

Bhupender Bohra - Jefferies LLC, Research Division

Okay, okay. And just a follow on actually on the M&A pipeline. If you could just give us some color on the M&A pipeline with respect to your distribution business? Which of these platforms still remains your priority going forward?

Robert D. Starr

Bhupender, it's a really good question. I hope what you've seen from the acquisitions that we've completed is that we have a primary focus in building out our fluid power relationship and geographic footprint with Parker. We certainly are keenly interested in continuing to grow our electrical and automation platform, really with the foundation of Minarik and Zeller, we have a great capability there and a great management team that we know can effectively integrate acquisitions and grow. And at the same time, when you look at an acquisition like Ohio Gear & Transmission, we still want to invest in areas where we have not had a strong geographic presence before, be able to establish that footprint with a power transmission motion control acquisition and then augment it with additional fluid power and electrical and automation capabilities to get that synergy sale.

Operator

Next question is from the line of Matt Duncan from Stephens Inc.

Matt Duncan - Stephens Inc., Research Division

This is just a follow-up to that last question on the M&A side. It looks like based on the corporate expense guidance for the year that those costs are going to jump a couple of million dollars in the fourth quarter. Does that suggest maybe you guys are getting a little bit more active on the M&A front here in the short run?

Neal J. Keating

That's typically one of the expense items that ebbs and flows by quarter. So that's not an unfair conclusion to draw.

Robert D. Starr

Yes. Matt, I would also point out, not unlike other companies we're seeing year-over-year increases in our medical expense. And that would also be reflected in corporate year.

Matt Duncan - Stephens Inc., Research Division

Okay. Neal, on the size of M&A opportunities that are out there. Are you seeing any larger ones? Or are they still kind of like in that smaller range or is most of what's coming across the drazzle?

Neal J. Keating

Matt, we've seen a couple larger ones. We would like to do a larger one in Distribution. And certainly, what you're seeing characterized, at least since we did Zeller last year -- it just comes out of the fact that when you look simply at a number of ones that are out there, they are typically smaller. The ones that we've done recently are a little bit smaller than we would typically do. However, it really has helped us dramatically increase the number of Parker stores that we have in our lineup today, which is obviously, very important to us strategically. We're going to be very cautious on the larger ones given, just frankly, the uncertainty that we see out in the marketplace. But we also feel that the management team that we have in place has done a pretty good job in assessing those acquisitions.

Matt Duncan - Stephens Inc., Research Division

Okay. And then a couple of questions on the outlook here for KIT. So look, I guess October is up 3% or 4%. I'm trying to remember, did Sandy hurt you guys last year just given where you're located?

Neal J. Keating

I don't think it really hurt us in any meaningful way. We were able to automatically reroute calls and serve customers from other locations. We obviously had some shutdown of customers. We actually assess that and it really didn't move the needle very much for us.

Matt Duncan - Stephens Inc., Research Division

Okay. So if I look at the guidance for the year, it implies that you probably need about 5% to 10% organic growth rate at KIT in the fourth quarter to get to the guidance. And I think you got an extra selling days, so that's probably part of how you get from 3% to 4% in October up to that 5% to 10% range. But are you counting on some underlying demand improvement going forward or is it just the easier comp that gets you to that growth level?

Robert D. Starr

Matt, it's really a bit of both, but I would say the comps in Q4 do get easier relative to last year as you recall, we had a very challenging fourth quarter in 2012. But we are looking for continued, granted, slow improvement in underlying economic growth that should translate into improved sales.

Matt Duncan - Stephens Inc., Research Division

Okay. And then last thing on the KIT margin. It sounds like the reversal of variable comp accruals helped a couple of million dollars in the quarter, so if I adjust your operating margin for that, you're kind of in the 4.6, 4.7 range. And that's pretty close to what you're guiding to for the fourth quarter. And again, I know it's a little early to be talking about next year but, I know, Neal, a couple of years ago, when you laid out 2014 goals, the operating margin hope was certainly above where you're at right now. I think it was 7% that you were trying to get to. How quickly do now think you can get up to that level from where you are?

Neal J. Keating

Matt, what I'd prefer to do is that we'll talk about that when we do our fourth quarter call. Because you're right, we had a 7% target for 2014. And given lower GDP growth since 2009, we came out of the recovery, we and I think others felt that we would have a stronger underlying level of organic -- excuse me, of GDP growth than we have encountered. We also expected that we would have more acquisition contribution as well. So we're going to fall short on the top line. We're going to fall short on the margin. We're confident that we're going to be able to make significant improvement from 2013 to 2014. But we also understand that we need to invest in this business to drive some improvement in that top line growth. So those are some of the discussions and analysis that we're going through right now, that we'll talk more about after the year is complete.

Matt Duncan - Stephens Inc., Research Division

Obviously, I get that you need a better economy to get the sort of margin improvement that you want there and maybe another way to think about this is what level of organic revenue growth do you need to drive sort of 50 to 100 basis points of operating margin expansion in the year. Because a big part of it is you just got to grow that business organically to get leverage.

Robert D. Starr

We would agree. I mean organic growth is very critical to achieving our margin targets. And I just want to address your comment regarding the incentive comp in the quarter for Distribution. The $2 million we were talking to, which was an estimate, really, was an overall incentive comp. And keep in mind, our incentive comp numbers did come down at corporate as well. So I just want to be clear.

Matt Duncan - Stephens Inc., Research Division

Okay, that helps, Rob.

Robert D. Starr

Yes, we have a number of give and takes within distribution, of which incentive comp was one of them. I just want to make sure that we're all on the same page.

Operator

Our last question comes from the line of Jeff Hammond from KeyBanc Capital Markets.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Just in your queue, you mentioned a couple of dynamics in a few year acquired businesses over the last few years. Can you just expound on what's going on there and how we should think about goodwill impacts, et cetera?

Neal J. Keating

Sure. I'll start, Jeff. I think that we're in the early stages of our goodwill analysis, which we do each year. I think, in fact, if you look at our third quarter queue from last year, you would have seen some similar language for both our U.K. acquisition and our Vermont acquisition. I think what's probably new this year is the language around going to the Global Aerosystems acquisition. And quite frankly, the reductions in Boeing's external engineering resources over the course of last year has been pretty dramatic, on a percentage of almost 50%. So that's been a significant impact for us from year-to-year. Boeing, as we work with Boeing, we continued to feel encouraged that as they announced to begin development of the 777X, there's going to be a significant demand for our engineering services. And in fact, we expect to be able to effectively leverage our selection as supplier of the year, for that business at Boeing last year. But that's really the new one and the one where we've had the most significant change from year-to-year. Some of our other businesses, obviously, as we've experienced pushouts on things like everything from a Joint Strike Fighter, when we acquired the U.K. business some 5 years ago, we thought that we'd be at much higher production rates for the JSF. That impacts us. Also, P8 and B22 were at lower levels than had been anticipated either by Textran or by Boeing when we made those acquisition a number of years ago. So those are the things that all go into the analysis. But I would say the one thing that's really different from year-to-year is the engineering systems one.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Okay. And then just a quick follow-up on Distribution. Given that we've kind of had this persistently sluggish environment, can you just talk about what you're seeing on the competitive front? How you're seeing price cost or point-of-sale pricing and how that's impacting or not impacting kind of the margin trajectory?

Neal J. Keating

Jeff, I think that we've seen margin pressure. I think one of our larger competitors actually commented about that recently. Obviously, everybody's trying to grow their business, and at times, part of that comes at the expense of margin. We're trying really very hard to manage that because that's a very slippery slope, as you know. But I think certainly there's been margin pressure from year-to-year that's impacted the industry overall.

Operator

We have no questions in the queue. Should we conclude the call?

Eric B. Remington

Yes. Thank you, Bhupender, and thank you, everybody, for joining us today. We look forward to speaking to you again when report our fourth quarter and full year results in February.

Operator

Ladies and gentlemen, that concludes your call for today. Thank you for joining. You may now disconnect.

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