Kaman Corporation Form 10-Q for Quarterly Period Ended September 29, 2006



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

x
Quarterly Report Pursuant To Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For The Quarterly Period Ended September 29, 2006

OR

o
Transition Report Pursuant To Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
Transition Period From ___ to ___

Commission File No. 0-1093

KAMAN CORPORATION

(Exact name of registrant as specified in its charter)

Connecticut
 
06-0613548
(State or other jurisdiction
 
(I.R.S. Employer
of incorporation or organization)
 
Identification No.)

1332 Blue Hills Avenue
Bloomfield, Connecticut 06002
(Address of principal executive offices)

(860) 243-7100
Registrant's telephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x
 
No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. 
 
Large accelerated filer o
 
Accelerated filer x
 
Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).          

Yes o
 
No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of October 27, 2006:

Common Stock
24,083,868
 
Page 1 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements:


Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited)

 
 
September 29, 2006 
     
December 31, 2005
   
Assets:
                               
Current assets:
                               
Cash and cash equivalents
       
$
12,307
             
$
12,998
 
Accounts receivable, net
         
203,263
               
176,285
 
Inventories:
                               
Contracts and other
                               
work in process
 
$
82,799
             
$
81,014
       
Finished goods
   
14,670
               
14,764
       
Merchandise for resale
   
123,364
   
220,833
         
124,936
   
220,714
 
                                 
Deferred income taxes
         
27,414
               
31,652
 
Other current assets
         
19,979
               
17,159
 
Total current assets
         
483,796
               
458,808
 
                                 
Property, plant & equip., at cost
   
167,111
               
167,499
       
Less accumulated depreciation
                               
and amortization
   
115,364
               
115,907
       
Net property, plant & equipment
         
51,747
               
51,592
 
                                 
Goodwill
         
55,775
               
54,693
 
Other intangible assets, net
         
19,348
               
19,836
 
Deferred income taxes
         
10,102
               
7,908
 
Other assets, net
         
7,248
               
5,660
 
                                 
Total assets
       
$
628,016
             
$
598,497
 
                                 





See accompanying notes to condensed consolidated financial statements.


Page 2 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:


Condensed Consolidated Balance Sheets (continued)
(In thousands)
(Unaudited)

     
September 29, 2006  
   
December 31,
2005 
 
Liabilities and Shareholders' Equity:
             
               
Current liabilities:
             
               
Notes payable
 
$
11,112
 
$
915
 
Current portion of long-term debt
   
1,551
   
1,660
 
Accounts payable - trade
   
87,833
   
94,716
 
Accrued pension costs
   
16,417
   
13,150
 
Accrued contract losses
   
11,646
   
19,950
 
Other accrued liabilities
   
35,851
   
41,077
 
Advances on contracts
   
9,806
   
14,513
 
Other current liabilities
   
28,193
   
30,872
 
Income taxes payable
   
5,590
   
6,423
 
               
Total current liabilities
   
207,999
   
223,276
 
               
Commitments and contingencies (Note 11)
   
-
   
-
 
Long-term debt, excl. current portion
   
85,058
   
62,235
 
Other long-term liabilities
   
47,307
   
43,232
 
Shareholders' equity:
             
Common stock 
   
24,565
   
24,565
 
Additional paid in capital
   
60,177
   
58,637
 
Retained earnings
   
212,513
   
199,383
 
Other shareholders’ equity
   
(9,603
)
 
(12,831
)
               
Total liabilities and shareholders’ equity 
 
$
628,016
 
$
598,497
 




 


See accompanying notes to condensed consolidated financial statements.
 
 
Page 3 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:


Condensed Consolidated Statements of Operations
(In thousands except per share amounts)
(Unaudited)


     
For the Three Months Ended 
 
For the Nine Months Ended 
 
                           
 
   
September 29,
2006 
   
September 30,
2005
   
September 29,
2006
   
September 30,
2005
 
                           
Net sales
 
$
307,610
 
$
278,111
 
$
897,214
 
$
812,680
 
                           
Costs and expenses:
                         
Cost of sales
   
223,484
   
215,899
   
651,238
   
608,883
 
Selling, general and
                         
administrative expense
   
68,543
   
67,036
   
205,625
   
193,237
 
Net (gain)/loss on sale or
disposal of assets
   
92
   
144
   
36
   
51
 
Other operating income
   
(729
)
 
(588
)
 
(1,552
)
 
(1,571
)
Interest expense, net
   
1,648
   
562
   
4,536
   
1,912
 
Other expense, net
   
164
   
135
   
727
   
843
 
     
293,202
   
283,188
   
860,610
   
803,355
 
                           
Earnings (loss) before
income taxes
   
14,408
   
(5,077
)
 
36,604
   
9,325
 
Income tax (expense) benefit
   
(5,670
)
 
1,465
   
(14,460
)
 
(5,475
)
                           
Net earnings (loss)
 
$
8,738
 
$
(3,612
)
$
22,144
 
$
3,850
 
                           
Net earnings (loss) per share:
                         
Basic
 
$
.36
 
$
(.16
)
$
.92
 
$
.17
 
Diluted (1)
 
$
.36
 
$
(.16
)
$
.91
 
$
.17
 
                           
Average shares outstanding:
                         
Basic
   
24,067
   
22,920
   
24,012
   
22,838
 
Diluted
   
24,794
   
22,920
   
24,854
   
23,767
 
                           
Dividends declared per share
 
$
.125
 
$
.125
 
$
.375
 
$
.36
 
 
(1) The calculated diluted per share amounts for the three months and nine months ended September 30, 2005 are anti-dilutive, therefore, amounts shown are equal to the basic per share calculation.

See accompanying notes to condensed consolidated financial statements.

Page 4 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:


Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
 
For the Nine Months Ended 
               
     
September 29,
2006  
   
September 30,
2005 
 
               
Cash flows from operating activities:
             
Net earnings
 
$
22,144
 
$
3,850
 
Depreciation and amortization
   
7,885
   
6,875
 
Provision (recovery) for losses on accounts receivable
   
(407
)
 
(799
)
Net (gain)/loss on sale or disposal of assets
   
36
   
51
 
Deferred income taxes
   
2,146
   
1,427
 
Other, net
   
6,174
   
2,925
 
Changes in current assets and liabilities,
             
excluding effects of acquisitions:
             
Accounts receivable
   
(26,317
)
 
(6,987
)
Inventory
   
115
   
1,533
 
Accounts payable
   
(8,398
)
 
(5,179
)
Accrued contract losses
   
(8,322
)
 
(11,205
)
Advances on contracts
   
(4,708
)
 
(2,872
)
Changes in other current assets and liabilities
   
(7,674
)
 
8,725
 
Income taxes payable
   
(1,108
)
 
(2,626
)
               
Cash provided by (used in) operating activities
   
(18,434
)
 
(4,282
)
               
Cash flows from investing activities:
             
Proceeds from sale of assets
   
492
   
300
 
Expenditures for property, plant & equipment
   
(8,332
)
 
(6,339
)
Acquisition of businesses, less cash acquired
   
(541
)
 
(31,581
)
Other, net
   
(1,759
)
 
60
 
               
Cash provided by (used in) investing activities
   
(10,140
)
 
(37,560
)
               




See accompanying notes to condensed consolidated financial statements.

 
Page 5 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Condensed Consolidated Statements of Cash Flows (continued)
(In thousands)
(Unaudited)

 
 
For the Nine Months Ended 
               
     
September 29,
2006  
   
September 30,
2005 
 
               
Cash flows from financing activities:
             
               
Changes in notes payable
   
10,196
   
4,260
 
Changes in book overdraft
   
1,450
   
2,508
 
Changes in debt
   
22,714
   
40,899
 
Proceeds from exercise of employee stock plans
   
1,878
   
751
 
Dividends paid
   
(8,992
)
 
(7,865
)
Other
   
272
   
48
 
               
Cash provided by (used in) financing activities
   
27,518
   
40,601
 
               
Net increase (decrease) in cash and cash equivalents
   
(1,056
)
 
(1,241
)
               
Effect of exchange rate changes on cash and cash equivalents
   
365
   
(298
)
               
Cash and cash equivalents at beginning of period
   
12,998
   
12,369
 
               
Cash and cash equivalents at end of period
 
$
12,307
 
$
10,830
 

Supplemental Disclosure of Cash Flow Information:

Non-cash financing activity for the nine months ended September 29, 2006 includes the conversion of 276 debentures for a total value of $276 into 11,801 shares of common stock, issued from treasury.

See accompanying notes to condensed consolidated financial statements.

Notes to Condensed Consolidated Financial Statements (In thousands) (Unaudited)

1. Basis of Presentation

The December 31, 2005 condensed consolidated balance sheet amounts have been derived from the previously audited consolidated balance sheet of Kaman Corporation and subsidiaries. In the opinion of management, the balance of the condensed financial information reflects all adjustments necessary for a fair presentation of financial position, results of operations and cash flows for the interim periods presented, all of which are of a normal recurring nature, unless otherwise disclosed in this report. Certain amounts in prior period’s condensed consolidated financial statements have been reclassified to conform with current year presentation.

Page 6 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued (In thousands) (Unaudited)

The company has a calendar year-end; however, its first three fiscal quarters follow a 13-week convention, with each quarter ending on a Friday. The third quarter for 2006 and 2005 ended on September 29, 2006 and September 30, 2005, respectively.

The statements should be read in conjunction with the consolidated financial statements and notes included in the company’s annual report on Form 10-K for the year ended December 31, 2005. The results of operations for the interim periods presented are not necessarily indicative of trends or of results to be expected for the entire year.

Recently Issued Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109”, which clarifies the accounting for uncertainty in tax positions. This Interpretation clarifies the methodology for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Although for the company this Interpretation is not effective until January 1, 2007, this statement does require disclosure of the effects of adoption in the December 31, 2006 consolidated financial statements. We are in the process of determining the effect, if any, the adoption of FIN 48 will have on our financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (SFAS 157), “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. We are currently evaluating the impact of SFAS 157, but do not expect the adoption of SFAS 157 to have a material impact on our consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (SFAS 158), “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)”. SFAS 158 requires that we recognize the overfunded or underfunded status of our defined benefit plans as an asset or liability in our 2006 year-end balance sheet, with changes in the funded status recognized through comprehensive income in the year in which they occur. We estimate the impact of adopting SFAS 158 to be approximately $10.7 million being reflected as a reduction of net assets on our balance sheet, with no impact to our statements of income or cash flows. SFAS 158 also requires measurement of the funded status of plans as of the end of the employer's fiscal year. We currently use December 31st as our measurement date which is our fiscal year end; therefore, the mandated measurement date provisions of SFAS 158 will not have any impact on our financial statements.

Cash Flow Items

Cash payments for interest were $4,779 and $2,996 for the nine months ended September 29, 2006 and September 30, 2005, respectively. Cash payments for income taxes, net of refunds, for those periods were $13,083 and $6,123, respectively.
 
Page 7 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued (In thousands) (Unaudited)

Comprehensive Income (Loss)

Comprehensive income (loss) was $8,909 and $(2,805) for the three months ended September 29, 2006 and September 30, 2005, respectively. Comprehensive income was $22,822 and $4,707 for the nine months ended September 29, 2006 and September 30, 2005, respectively. The changes to net earnings used to determine comprehensive income are comprised of foreign currency translation adjustments.

2. Accounts Receivable

Accounts receivable consist of the following:

     
September 29, 2006
   
December 31, 2005
 
               
Trade receivables
 
$
108,676
 
$
96,776
 
               
U.S. Government contracts:
             
Billed
   
26,726
   
16,140
 
Costs and accrued profit - not billed
   
4,040
   
956
 
               
Commercial and other government contracts:
             
Billed
   
25,960
   
19,569
 
Costs and accrued profit - not billed
   
40,853
   
46,244
 
               
Less allowance for doubtful accounts
   
(2,992
)
(3,400)
         
Total
 
$
203,263
 
$
176,285
 


3. Shareholders’ Equity

Changes in shareholders’ equity for the nine months ended September 29, 2006 were as follows:


Balance, January 1, 2006
 
$
269,754
 
         
Net earnings
   
22,144
 
Foreign currency translation adjustment
   
678
 
Comprehensive income
   
22,822
 
         
Dividends declared
   
(9,014
)
Employee stock plans
   
3,814
 
Debentures
   
276
 
         
Balance, September 29, 2006
 
$
287,652
 


 
Page 8 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued
(In thousands except per share amounts) (Unaudited)
4. Earnings (Loss) Per Share

The following table presents a reconciliation of the numerators and denominators of basic and diluted earnings per share:
 
 
For the Three Months Ended 
For the Nine Months Ended
                           
     
September 29, 2006
   
September 30, 2005 
   
September 29, 2006 
   
September 30, 2005 
 
Basic:
                         
                           
Net earnings/(loss)
 
$
8,738
 
$
(3,612
)
$
22,144
 
$
3,850
 
Weighted average number of
                         
shares outstanding
   
24,067
   
22,920
   
24,012
   
22,838
 
                           
Net earnings/(loss)
per share - basic
 
$
.36
 
$
(.16
)
$
.92
 
$
.17
 
                           
Diluted:
                         
                           
Net earnings/(loss)
 
$
8,738
 
$
(3,612
)
$
22,144
 
$
3,850
 
Elimination of interest expense
                         
on 6% subordinated convertible
                         
debentures (net after taxes)
   
148
   
-
   
459
   
423
 
Net earnings/(loss) (as adjusted)
 
$
8,886
 
$
(3,612
)
$
22,603
 
$
4,273
 
                           
Weighted average number of
                         
shares outstanding
   
24,067
   
22,920
   
24,012
   
22,838
 
Weighted averages shares issuable
                         
on conversion of 6%
subordinated convertible
                         
debentures
   
703
   
-
   
725
   
800
 
Weighted average shares issuable
         
             
on exercise of dilutive stock options
   
24
   
-
   
117
   
129
 
Total
   
24,794
   
22,920
   
24,854
   
23,767
 
                           
Net earnings/(loss) per share - diluted
 
$
.36
 
$
(.16
)
$
.91
 
$
.17
 

Potentially dilutive average shares outstanding of 1,038 for the three months ended September 30, 2005 from the conversion of the debentures and the exercise of dilutive stock options have been excluded from the calculation of average diluted shares outstanding due to the loss from operations in that year. Additionally, after-tax interest savings on convertible debentures of $113 for the three months ended September 30, 2005 has been excluded from net earnings (loss) due to the loss from operations in that year.
 
Excluded from the net earnings/(loss) per share - diluted calculation are 88 options that are anti-dilutive based on the average stock price for the nine months ended September 30, 2005. There were no anti-dilutive shares for the three months ended September 30, 2005. Excluded from the net earnings/(loss) per share - diluted calculation are 150 and 74 options that are anti-dilutive for the three months and nine months ended September 29, 2006, respectively.

Page 9 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued (In thousands) (Unaudited)

5. Exit Activity

The following table displays the activity and balances of various exit activities as of and for the nine months ended September 29, 2006:

Balance at January 1, 2006
 
$
6,007
 
Additions to accrual
   
-
 
Cash payments
   
(1,769
)
Release to income
   
-
 
Net adjustment to goodwill
   
(600
)
Balance at September 29, 2006
 
$
3,638
 

A summary of the exit activities is described below:

In connection with the acquisition of Musicorp in August 2005, the company accrued $3,500 for certain exit costs. These costs relate primarily to lease consolidation and employee severance payments for reductions primarily in administrative and warehousing personnel. As part of finalizing its plans related to certain restructuring activities, the company recorded a net purchase price adjustment reducing goodwill by $600 during the third quarter of 2006. The total restructuring accrual as of September 29, 2006 was $956.

In connection with the Moosup, CT plant closure, the company recorded restructuring costs of $8,290 in 2002. The charge included $3,290 of severance related costs and $5,000 for closing the facility (including costs of an ongoing environmental remediation program and ultimate disposal). The remaining accrual as of September 29, 2006, which consists primarily of the estimated cost of ongoing environmental remediation, was $2,682.

These exit activity accruals are included in other current liabilities on the condensed consolidated balance sheets for the periods presented.

6. Warranty Reserve

The following table presents the activity and balances of accrued product warranty costs included in other current liabilities on the condensed consolidated balance sheets as of and for the nine months ended September 29, 2006:
 
Balance at January 1, 2006
 
$
4,304
 
Product warranty accrual
   
301
 
Warranty costs incurred
   
(2,456
)
Release to income
   
(41
)
Balance at September 29, 2006
 
$
2,108
 


 
Page 10 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued (In thousands) (Unaudited)

The following is a summary of significant warranty matters as of September 29, 2006:

The company continues to work to resolve two warranty-related matters that primarily impact our FMU-143 program at the Dayron facility. The first issue involves a supplier's recall of a switch embedded in certain bomb fuzes. The second warranty issue involves bomb fuzes manufactured for the U. S. Army utilizing systems which originated before Dayron was acquired by Kaman that have since been found to contain an incorrect part. The balance of the reserve for these two matters as of September 29, 2006 is $1,179. This represents management’s best estimate of the costs, including re-work, transportation costs and testing, currently expected to be incurred in resolving these matters. Although work continues on these warranty items, there have been delays as the Company responds to ongoing customer input regarding conduct of the work. Management currently anticipates that work will be completed during 2007.

As previously disclosed, in March 2005 the U.S. Attorney's Office for the Middle District of Florida and the Defense Criminal Investigative Service (DCIS) initiated an investigation into the second warranty matter discussed in the preceding paragraph. Dayron has cooperated fully with the authorities, working to resolve the matter in a mutually satisfactory manner. As of the date of this report, the company has not received any notification from the authorities regarding the resolution of the investigation. 

On June 29, 2005, the company notified its two affected customers of a non-conforming part that may have an impact on certain aircraft panels manufactured by the Aerostructures facility in Wichita, Kansas, beginning in September 2002. As a result of this matter, the company recorded a warranty accrual of $1,040 during 2005, in anticipation of incurring its estimated share of certain costs to replace and install the panels on certain aircraft. As of September 29, 2006, $677 is available for the resolution of this matter. Management is working with its customers to resolve this issue in a mutually satisfactory manner.

7. Accrued Contract Losses

The following is a summary of activity and balances of accrued contract losses as of and for the nine months ended September 29, 2006:
 
Balance at January 1, 2006
 
$
19,950
 
Additions to loss accrual
   
8,760
 
Costs incurred
   
(16,356
)
Release to income
   
(708
)
Balance at September 29, 2006
 
$
11,646
 

The following is a summary of significant accrued contract loss matters as of September 29, 2006:

During the third quarter of 2006, the company recorded an additional $2,497 pretax charge to cover additional anticipated costs to complete the SH-2G(A) Helicopter Program for the Royal Australian Navy. The total pretax charge recorded to date during 2006 was $7,814. This contract has been in a loss position since 2002. The remaining accrued contract loss for this contract as of September 29, 2006 was $11,022. This contract loss accrual continues to be monitored and adjusted as necessary to reflect the anticipated cost necessary to complete this complex program.

 
Page 11 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued (In thousands) (Unaudited)
 
8. Pension Cost

Components of net pension cost for the Qualified Pension Plan and Supplemental Employees’ Retirement Plan (SERP) are as follows:

 
 
Qualified Pension Plan
     
For the Three Months Ended
   
For the Nine Months Ended
 
                           
 
   
September 29,
2006
   
September 30,
2005
   
September 29,
2006
   
September 30,
2005
 
                           
Service cost for benefits earned
 
$
3,143
 
$
2,873
 
$
9,427
 
$
8,619
 
                           
Interest cost on projected
                         
benefit obligation
   
6,602
   
6,367
   
19,808
   
19,101
 
                           
Expected return on plan assets
   
(7,362
)
 
(7,119
)
 
(22,086
)
 
(21,357
)
                           
Recognized net (gains) losses
   
752
   
419
   
2,256
   
1,255
 
Net periodic benefit cost
 
$
3,135
 
$
2,540
 
$
9,405
 
$
7,618
 


 
 
SERP
     
For the Three Months Ended 
   
For the Nine Months Ended 
 
                           
     
September 29,
2006 
 
 
September 30,
2005 
 
 
September 29,
2006 
 
 
September 30,
2005 
 
                           
Service cost for benefits earned
 
$
528
 
$
352
 
$
1,584
 
$
1,056
 
                           
Interest cost on projected
                         
benefit obligation
   
432
   
333
   
1,296
   
997
 
                           
Expected return on plan assets
   
-
   
-
   
-
   
-
 
                           
Recognized net (gains) losses
   
390
   
55
   
1,168
   
167
 
Net periodic benefit cost
 
$
1,350
 
$
740
 
$
4,048
 
$
2,220
 

The company expects to contribute $9,810 to the qualified pension plan for the 2006 plan year of which $4,905 was paid though the nine months ended September 29, 2006. For the 2005 plan year, the company contributed $4,747 to the qualified pension plan.


Page 12 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued (In thousands) (Unaudited)

9. Business Segments

Summarized financial information by business segment is as follows:

 
   
September 29,
2006 
   
December 31,
2005
 
Identifiable assets:
             
               
Aerospace
 
$
283,687
 
$
266,369
 
Industrial Distribution
   
182,636
   
175,725
 
Music
   
123,076
   
117,347
 
Corporate
   
38,617
   
39,056
 
               
   
$
628,016
 
$
598,497
 

     
For the Three Months Ended 
   
For the Nine Months Ended 
 
                           
 
   
September 29,
2006 
   
September 30,
2005
   
September 29,
2006
   
September 30,
2005
 
Net sales:
                         
                           
Aerospace
 
$
85,343
 
$
70,630
 
$
233,377
 
$
212,350
 
Industrial Distribution
   
166,746
   
156,449
   
507,799
   
469,909
 
Music
   
55,521
   
51,032
   
156,038
   
130,421
 
                           
   
$
307,610
 
$
278,111
 
$
897,214
 
$
812,680
 
Operating income (loss):
                         
                           
Aerospace
 
$
11,809
 
$
(324
)
$
32,473
 
$
16,839
 
Industrial Distribution
   
8,590
   
5,218
   
28,663
   
22,074
 
Music
   
3,781
   
3,370
   
6,684
   
7,798
 
Net gain (loss) on sale or
disposal of assets
   
(92
)
 
(144
)
 
(36
)
 
(51
)
Corporate expense
   
(7,868
)
 
(12,500
)
 
(25,917
)
 
(34,580
)
                           
Operating income (loss)
   
16,220
   
(4,380
)
 
41,867
   
12,080
 
                           
Interest expense, net
   
(1,648
)
 
(562
)
 
(4,536
)
 
(1,912
)
                           
Other expense, net
   
(164
)
 
(135
)
 
(727
)
 
(843
)
                           
Earnings (loss) before
income taxes
 
$
14,408
 
$
(5,077
)
$
36,604
 
$
9,325
 





Page 13 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued (In thousands) (Unaudited)

10. Share-Based Arrangements 
 
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R) (SFAS 123(R)) related to accounting for share-based payments and, accordingly, we are now recording compensation expense for share-based awards based upon an assessment of the grant date fair value of the awards. Prior to 2006, share-based compensation was accounted for in accordance with Accounting Principles Board Opinion No. 25. We are using the modified prospective method of adoption, which allows us to apply SFAS 123(R) on a going-forward basis rather than restating prior periods.

The company accounts for stock options and restricted stock as equity awards whereas the stock appreciation rights and employee stock purchase plan are accounted for as liability awards.

The following table summarizes share-based compensation expense recorded during each period presented:
 


 
 
Three Months Ended
Nine Months Ended
   
September 29,
2006 
   
September 30,
2005
   
September 29,
2006
   
September 30,
2005
 
                           
Stock options
 
$
233
 
$
-
 
$
696
 
$
-
 
Restricted stock awards
   
77
   
105
   
640
   
449
 
Stock appreciation rights
   
(10
)
 
4,416
   
485
   
8,354
 
Employee stock purchase plan
   
50
   
-
   
156
   
-
 
Total share-based compensation
expense
 
$
350
 
$
4,521
 
$
1,977
 
 
$
8,803
 

Compensation expense for stock options and restricted stock awards, which is recorded in general and administrative expense, is recognized on a straight-line basis over the vesting period of the award. The expense recorded for stock appreciation rights includes a cumulative effect adjustment of $105 recorded as of the beginning of 2006 as a result of adopting SFAS 123(R) to reflect the effect of changing our valuation methodology to record compensation expense from intrinsic value to fair value.



 
Page 14 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued
(In thousands except share and per share amounts) (Unaudited)
Stock Option Accounting

The following table reflects pro forma net earnings and earnings per share for the three and nine months ended September 30, 2005 as if we had applied the fair value method.
 
 
     
For the Three Months 
       
For the Nine Months 
     
     
Ended 
       
Ended 
     
     
September 30, 2005
       
September 30, 2005 
     
Net earnings (loss):
                         
As reported
 
$
( 3,612
)
     
$
3,850
       
Stock compensation expense reported in
                         
net earnings, net of tax effect
   
2,803
   
*
   
5,458
   
*
 
Less stock compensation expense, net
                         
of tax effect
   
(2,989
)
 
**
   
(6,015
)
 
**
 
 
                         
Pro forma net earnings (loss)
 
$
(3,798
)
     
$
3,293
       
                           
Earnings (loss) per share - basic:
                         
As reported
   
(0.16
)
       
0.17
       
Pro forma
   
(0.17
)
       
0.14
       
                           
Earnings (loss) per share - diluted:
                         
As reported
   
(0.16
)
       
0.17
       
Pro forma
   
(0.17
)
       
0.14
       

* The three months ended September 30, 2005 included stock appreciation rights expense of $2,738 and restricted stock expense of $65, both net of tax. The nine months ended September 30, 2005 included stock appreciation rights expense of $5,180 and restricted stock expense of $278, both net of tax.

** The three months ended September 30, 2005 included stock appreciation rights expense of $2,738, restricted stock expense of $65, stock options expense of $156 and Employees Stock Purchase Plan (ESPP) expense of $30, all of which are net of tax. The nine months ended September 30, 2005 included stock appreciation rights expense of $5,180, restricted stock expense of $278, stock options expense of $465 and ESPP expense of $92, all of which are net of tax.

Stock Incentive Plan 

The 2003 Stock Incentive Plan (the “2003 Plan”) allows for the issuance of 2,000,000 shares of common stock. As did the predecessor plan, the 2003 Plan provides for equity compensation awards, including principally incentive and non-statutory stock options, restricted stock, stock appreciation rights, and long-term incentive plan (LTIP) awards.

Stock options are granted with an exercise price equal to the average market price of our stock at the date of grant. Options and Stock Appreciation Rights (SARs) granted under the plan generally expire ten years from the date of grant and vest 20% each year over a 5-year period on each of the first five anniversaries from the date of grant. Restricted stock awards (RSA) are generally granted with restrictions that lapse at the rate of 20% per year over a 5-year period on each of the first five anniversaries from the date of grant. Generally, these awards are subject to forfeiture if a recipient separates from service with the company.

 
Page 15 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued
(In thousands except share and per share amounts) (Unaudited)

Stock Option activity was as follows:
 
Stock options outstanding:
   
Options
   
Weighted-
Average
Exercise Price
 
Balance at January 1, 2006
   
910,243
 
$
13.13
 
Options granted
   
161,600
   
21.32
 
Options exercised
   
(69,070
)
 
13.05
 
Options cancelled
   
(31,360
)
 
16.42
 
Balance at September 29, 2006
   
971,413
 
$
14.39
 

The following table presents information regarding options outstanding as of September 29, 2006:

Weighted-average contractual remaining term - options outstanding
   
6.66 years
 
Aggregate intrinsic value - options outstanding
 
$
4,244
 
Options exercisable
   
424,594
 
Weighted-average exercise price - options exercisable
 
$
14.04
 
Aggregate intrinsic value - options exercisable
 
$
1,803
 
Weighted-average contractual remaining term - options exercisable
   
4.82 years
 

Intrinsic value represents the amount by which the market price of the stock on the measurement date exceeded the exercise price of the option. The intrinsic value on the date of exercise of options that were exercised during the third quarter and first nine months of 2006 was $6 and $709, respectively. The company’s policy for issuing shares upon stock option exercises is to issue those shares from treasury stock. The company currently has an open stock re-purchase plan which would enable the company to re-purchase shares as needed.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model. The following table indicates the weighted-average assumptions used in estimating fair value for the third quarter and first nine months of 2006 and 2005:

 
 
Three Months Ended
Nine Months Ended
 
   
September 29,
2006 
   
September 30,
2005
   
September 29,
2006
   
September 30,
2005
 
Expected option term
   
6.5 years
   
8 years
   
6.5 years
   
8 years
 
Expected volatility
   
39.5
%
 
36.8
%
 
41.5
%
 
39.8
%
Risk-free interest rate
   
4.7
%
 
4.2
%
 
4.5
%
 
4.2
%
Expected dividend yield
   
2.6
%
 
2.6
%
 
2.5
%
 
3.8
%
Per share fair value of options granted
 
$
6.63
 
$
6.87
 
$
7.96
 
$
3.73
 

Page 16 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued
(In thousands except share and per share amounts) (Unaudited)

The expected term for options represents an estimate of the period of time the stock options are expected to remain outstanding and is generally based upon an analysis of the historical behavior of stock option holders during the period from 1995 through 2005.

The volatility assumption is based on the historical daily price data of the company’s stock over a period equivalent to the weighted-average expected term of the options. Management evaluated whether there were factors during that period which were unusual and which would distort the volatility figure if used to estimate future volatility and concluded that there were no such factors.

The risk-free interest rate assumption is based upon the interpolation of various U.S. Treasury rates determined at the date of option grant. Expected dividends are based upon a historical analysis of our dividend yield over the past year.

Restricted Stock activity is as follows:
 
Restricted Stock outstanding:
   
RSA
   
Weighted-Average
Grant Date Fair Value
 
Nonvested at January 1, 2006
   
56,580
 
$
12.79
 
RSA granted
   
45,475
   
22.24
 
RSA vested
   
(46,260
)
 
17.35
 
RSA cancelled
   
(2,100
)
 
21.38
 
Nonvested at September 29, 2006
   
53,695
 
$
16.52
 

The grant date fair value for restricted stock is the average market price of the unrestricted shares on date of grant.

Stock Appreciation Rights activity is as follows:
 
SARs outstanding:
   
SARs
   
Weighted-Average
Exercise Price
 
Balance at January 1, 2006
   
241,780
 
$
11.51
 
SARs granted
   
-
   
-
 
SARs exercised
   
(102,720
)
 
12.67
 
SARs cancelled
   
-
   
-
 
Balance at September 29, 2006
   
139,060
 
$
10.65
 

Total cash paid to settle stock appreciation rights (at intrinsic value) for the three months and nine months ended September 29, 2006 was $0 and $1,227, respectively. Total cash paid to settle stock appreciation rights for the three months and nine months ended September 30, 2005 was $7,121 and $7,373, respectively. SARs are re-evaluated on a quarterly basis using the Black-Scholes valuation model.

We record a tax benefit and associated deferred tax asset for compensation expense recognized on non-qualified stock options and restricted stock for which we are allowed a tax deduction. For the three and nine months ended September 29, 2006, we recorded a tax benefit of $77 and $225, respectively, for these two types of compensation expense.

 
Page 17 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 1. Financial Statements, Continued:

Notes to Condensed Consolidated Financial Statements, Continued
(In thousands except for share and per share amounts) (Unaudited)

The windfall tax benefit is the tax benefit realized on the exercise of non-qualified stock options and disqualifying dispositions of stock acquired by exercise of incentive stock options and Employee Stock Purchase Plan stock purchases in excess of the deferred tax asset originally recorded. The total windfall tax benefit realized in the three months and nine months ended September 29, 2006 was $2 and $202, respectively.

As of September 29, 2006, future compensation costs related to non-vested stock options and restricted stock grants is $2,877. Management anticipates that this cost will be recognized over a weighted-average period of 1.93 years.
 
Employees Stock Purchase Plan

The Kaman Corporation ESPP allows employees to purchase common stock of the company, through payroll deductions, at 85% of the market value of shares at the time of purchase. Purchases under this Plan are made on a monthly basis. The plan provides for the grant of rights to employees to purchase a maximum of 1,500,000 shares of common stock. Under SFAS 123(R) this Plan is considered compensatory. Accordingly, we have recorded expense of $50 and $156 representing the 15% discount given to employees who purchased shares for the three and nine months ended September 29, 2006, respectively. As of September 29, 2006, there were 488,293 shares available under the plan.

11. Commitments and Contingencies
 
Management continues its discussions with NAVAIR regarding the potential purchase of the portion of the Bloomfield campus that the company currently leases from NAVAIR and has operated for several decades for the principal purpose of performing U.S. government contracts. On July 31, 2006, the company submitted an Offer to Purchase (OTP) to NAVAIR and the General Services Administration and management believes that it is proceeding through the U.S. government's formal review process. As of the date of this report, the company has not been notified of any formal action having been taken on the offer and at this time the company anticipates that the process may take several more months. The OTP provides that the company will assume all responsibility for environmental remediation of the facility as necessary to satisfy the Connecticut Department of Environmental Protection (CTDEP) under the Connecticut Transfer Act as consideration for transfer of the property. The company would not assume responsibility for the environmental remediation until after the property has been transferred to the company, which management estimates would take between three and six months following acceptance of the OTP.






Page 18 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to provide readers of our consolidated financial statements with the perspectives of management in the form of a narrative regarding our financial condition, results of operations, liquidity and certain other factors that may affect our future results. The MD&A is presented in seven sections:

I. Overview of Business
II. Third Quarter 2006 Highlights
III. Results of Operations
IV. Critical Accounting Estimates
V.  Liquidity and Capital Resources
VI. Contractual Obligations and Off-Balance Sheet Arrangements
VII.  Recent Accounting Standards

Our MD&A should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2005.

I.  OVERVIEW OF BUSINESS

Kaman Corporation is composed of three business segments: Aerospace, Industrial Distribution, and Music.

AEROSPACE SEGMENT

This segment has four primary operating units: Aerostructures, Fuzing, Helicopters and Kamatics.

The Aerostructures Division produces aircraft subassemblies and other parts for commercial and military airliners and helicopters. Its principal customers are Boeing and Sikorsky Aircraft Corporation. Operations involving the use of metals are conducted principally at the company's Jacksonville, Florida facility, while operations involving composite materials are conducted principally at the company's Wichita, Kansas (Plastic Fabricating Company) facility.

The Fuzing Division manufactures products for military and commercial markets, primarily related to military safe, arm and fuzing devices for several missile and bomb programs; as well as precision non-contact measuring systems for industrial and scientific use; and high reliability memory systems for airborne, shipboard, and ground-based programs. Principal customers include the U.S. military, Boeing, General Dynamics, Lockheed Martin and Raytheon. This division's operations are conducted at the Middletown, Connecticut and Orlando, Florida (Dayron) facilities.

The Helicopters Division supports and markets Kaman SH-2G maritime helicopters operating with foreign militaries as well as K-MAX® “aerial truck” helicopters operating with government and commercial customers in several countries. The SH-2G helicopter program generally consists of remanufacture of the division's SH-2F helicopters to the SH-2G configuration or refurbishment, upgrades and ongoing support of existing SH-2G helicopters. The SH-2, including its F and G configurations, was originally manufactured for the U.S. Navy. The SH-2G aircraft is currently in service with the Egyptian Air Force and the New Zealand and Polish navies. The division also has other small manufacturing programs and markets its helicopter engineering expertise on a subcontract basis. This division's operations are primarily conducted at the Bloomfield, Connecticut facility.

 
Page 19 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

 
Kamatics primarily manufactures proprietary self-lubricating bearings used in aircraft flight controls, turbine engines and landing gear. These bearings are currently used in nearly all military and commercial aircraft in production in North and South America and Europe. Kamatics also manufactures driveline couplings for helicopters. These are market-leading products for applications requiring a highly sophisticated level of engineering and specialization in the airframe bearing market. Operations are conducted at the Bloomfield, Connecticut and Dachsbach, Germany (RWG) facilities.

INDUSTRIAL DISTRIBUTION SEGMENT

The Industrial Distribution segment is the third largest power transmission/motion control industrial distributor in North America. We provide services and products including bearings, electrical/mechanical power transmission, fluid power, motion control and materials handling components to a broad spectrum of industrial markets throughout North America. Our locations consist of nearly 200 branches, distribution centers and call centers across the United States and in Canada and Mexico. The range of our footprint allows us to offer almost 2 million products, as well as value-added services, to more than 50,000 companies in 70 of the top 100 industrial markets in the United States.

MUSIC SEGMENT

The Music segment is the largest independent distributor of musical instruments and accessories in the United States, offering more than 20,000 products for amateurs and professionals. Our premium branded products, many of which are brought to the market on an exclusive basis, and our market-leading business-to-business systems for our customer base of over 10,000 retailers nationwide, contribute to the performance of the business. Our array of fretted instruments includes proprietary products, such as the Ovation® and Hamer® guitars, as well as premier products including Takamine® guitars which is under an exclusive distribution agreement. We offer an extended line of percussion products and accessories through Latin Percussion®, the leading supplier of hand percussion instruments. Additionally our exclusive distribution agreements with Gretsch® drums and Sabian® cymbals, along with our own CB®, Toca® and Gibraltar® lines have further enhanced our array of products offered.

While the vast majority of our sales are to North American customers, we continue to build our presence in key international markets including Europe, Asia, South America and Australia. Music segment operations are headquartered in Bloomfield, Connecticut and conducted from manufacturing plants in New Hartford, Connecticut and Scottsdale, Arizona, and strategically placed warehouse facilities that primarily cover the North American market.



Page 20 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

II.  THIRD QUARTER 2006 HIGHLIGHTS

The following is a summary of key events that occurred during the third quarter of 2006:

·  
Our net sales increased 10.6 percent compared to the third quarter of 2005.

·  
Even after eliminating the variety of charges recorded during both third quarters, our net earnings improved significantly compared to the third quarter of 2005 as a result of higher sales volume, increased gross profit and continued focus on controlling operating expenses.

·  
We recorded an additional $2.5 million charge related to an increase in anticipated costs to complete the SH-2G(A) program for the Royal Australian Navy (RAN) compared to an $11.0 million charge recorded during the third quarter of 2005. The total year to date 2006 charge is $7.8 million compared to a 2005 year to date charge of $14.3 million.

·  
The Aerospace segment overall had sales growth driven primarily by strong performance at the Aerostructures Division and the Fuzing Division's Middletown facility.

·  
The Industrial Distribution segment continued to experience strong sales and operating income during the third quarter of 2006.




















Page 21 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued
 
III.  RESULTS OF OPERATIONS

CONSOLIDATED RESULTS -

The following table presents selected financial data of the company for the third quarter and first nine months of 2006 compared to the third quarter and first nine months of 2005:

Selected Consolidated Financial Information
(In millions, except per share data)
       
 
 
For the Three Months Ended 
For the Nine Months Ended
                           
 
   
September 29,
2006
   
September 30, 2005
   
September 29, 2006
   
September 30, 2005
 
                           
Net sales
 
$
307.6
 
$
278.1
 
$
897.2
 
$
812.7
 
% change
   
10.6
%
 
12.9
%
 
10.4
%
 
10.0
%
                           
Gross profit
 
$
84.1
 
$
62.2
 
$
246.0
 
$
203.8
 
% of net sales
   
27.3
%
 
22.4
%
 
27.4
%
 
25.1
%
                           
Selling, general & administrative expenses (S,G&A)
 
$
68.5
 
$
67.0
 
$
205.6
 
$
193.2
 
% of net sales
   
22.3
%
 
24.1
%
 
22.9
%
 
23.8
%
                           
Operating income (loss)
 
$
16.2
 
$
(4.4
)
$
41.8
 
$
12.1
 
% of net sales
   
5.3
%
 
(1.6
)%
 
4.7
%
 
1.5
%
                           
Interest expense, net
 
$
1.6
 
$
0.6
 
$
4.5
 
$
1.9
 
Other expense, net
   
0.2
   
0.1
   
0.7
   
0.9
 
                           
Net earnings (loss)
 
$
8.7
 
$
(3.6
)
$
22.1
 
$
3.9
 
                           
Net earnings (loss) per share - basic
 
$
.36
 
$
(.16
)
$
.92
 
$
.17
 
Net earnings per share (loss) - diluted
   
.36
   
(.16
)
 
.91
   
.17
 

Note - all percentages in the MD&A are calculated based upon financial information in thousands.



Page 22 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

Results of Operations - Consolidated

NET SALES

Net sales increased $29.5 million in the third quarter of 2006 compared to the third quarter of 2005. Net sales increased $84.5 million for the first nine months of 2006 compared to the same period in 2005. The increase in sales for the third quarter of 2006 was primarily due to organic growth in both the Aerospace and Industrial Distribution segments. The Music segment, exclusive of Musicorp, also experienced an increase in sales for the third quarter of 2006 compared to the third quarter of 2005. Each operating segment within the company was an important contributor to the sales increase for year to date 2006 compared to the same period in 2005. The Industrial Distribution segment provided a significant portion of the additional sales as a result of continued stability within the industrial production markets. The Music segment’s year to date growth was primarily due to sales volume at Musicorp, which was acquired in August 2005. The Aerospace segment experienced sales growth on its existing and new programs partially due to stable economic conditions in the Aerospace industry.

GROSS PROFIT

Total gross profit increased $21.9 million or 35.2 percent for the third quarter of 2006 compared to the third quarter of 2005. Gross profit increased $42.2 million or 20.7 percent for the first nine months of 2006 compared to the same period in 2005. Gross profit as a percentage of sales (gross margin) has also improved for each period presented. The third quarter of 2006 gross profit includes a $2.5 million charge related to the Australian SH-2G(A) program as compared to an $11.0 million charge recorded during the third quarter of 2005. Charges for the first nine months of 2006 recorded on this program were $7.8 million as compared to the $14.3 million recorded through the first nine months of 2005. These charges have resulted in lower gross profit for both years, which distorts period over period comparisons. The 2006 charges were essentially offset by an increase in overall gross profit, primarily due to higher sales volume, at the other Aerospace operating units and Industrial Distribution and Music segments.

SELLING, GENERAL & ADMINISTRATIVE EXPENSES

The S,G&A expense increase of $1.5 million or 2.2 percent during the third quarter of 2006 compared to the third quarter of 2005 was primarily attributable to the following items:

  
Music segment S,G&A expense increased $1.1 million, a portion of which relates to the addition of Musicorp expense. The remaining amount relates to an increase in operating expenses including personnel costs and pension expense due to an increase in the total plan contribution for 2006.


 
Industrial Distribution segment S,G&A expense increased $2.1 million primarily due to expenses related to higher sales volume, an increase in pension expense due to an increase in the total plan contribution for 2006 as well as higher personnel expenses partially attributable to an increase in headcount. 

Page 23 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

·  
The Aerospace segment S,G&A increased $2.9 million due to increased commission expense principally driven by greater sales volume and higher personnel costs attributable to increased headcount in most of the operating units

·  
Corporate S,G&A expense decreased $4.6 million. The decrease is primarily due to stock appreciation rights (SARs) expense being $4.4 million lower in the third quarter of 2006 compared to the third quarter of 2005. The change in SARs expense is primarily due to (a) a significantly smaller number of SARs outstanding at the end of the third quarter of 2006 compared to the same point in 2005 and (b) the relative changes in the stock price during the third quarter in 2006 as compared to 2005. Additionally, during the third quarter of 2005 the company incurred consulting expenses of $1.1 million related to the recapitalization. There were no such expenses during the third quarter of 2006. The decrease in these expenses was slightly offset by higher employee related expenses as well as higher stock compensation expense due to the adoption of SFAS 123(R). 

The S,G&A expense increase of $12.4 million or 6.4 percent during the first nine months of 2006 compared to the first nine months of 2005 was primarily attributable to the following items:

·  
Music segment S,G&A expense increased $7.2 million substantially all of which relates to Musicorp S,G&A expense.

·  
Industrial Distribution segment S,G&A expense increased $7.7 million primarily due to expenses related to higher sales volume, an increase in pension expense and higher personnel related expenses partially attributable to an increase in headcount.

·  
The Aerospace segment S,G&A increased $6.2 million primarily due to increased commission expense as a result of higher manufacturing volume and an increase in headcount.

·  
Corporate S,G&A expense decreased $8.7 million, primarily due to lower SARs expense of $7.9 million compared to 2005, the absence of $2.1 million of recapitalization consulting fees during 2006 as compared to 2005 as well as an insurance recovery during 2006 of $0.5 million in legal expenses associated with the recapitalization litigation. The decrease in these expenses was slightly offset by higher employee related expenses related to incentive compensation and insurance as well as higher stock compensation expense due to the adoption of SFAS 123(R).
 
OPERATING INCOME

Operating income improved by $20.6 million for the third quarter of 2006 compared to the third quarter of 2005. Operating income for the first nine months of 2006 increased $29.8 million compared to the first nine months of 2005. The improved operating income for both the third quarter and year to date 2006 compared to the same periods in 2005 was primarily attributable to increased operating income for the Industrial Distribution segment and the Aerospace segment, partially due to stronger performance at most of the operating units as well as lower charges related to the Australian helicopter program. Although the Music segment experienced modest growth in operating income for the third quarter of 2006 compared to the same period in 2005, overall year to date operating income for this segment continues to be below the prior year to date results. This was primarily due to lower consumer spending during the first and second quarters of 2006. The decrease in Corporate S,G&A expense discussed above contributed substantially to the improvement in operating income for both the quarter and the nine-month period.
 
Page 24 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

ADDITIONAL CONSOLIDATED RESULTS

Interest expense, net increased 193.2 percent to $1.6 million for the third quarter of 2006 compared to $0.6 million for the third quarter of 2005. Interest expense, net also increased 137.3 percent to $4.5 million for the first nine months of 2006 compared to $1.9 million for the first nine months of 2005. Interest expense, net generally consists of interest charged on the revolving credit facility offset by interest income. The increase is primarily due to higher borrowings to fund greater working capital requirements, as well as higher interest rates charged on borrowings during 2006 as compared to 2005. Additionally the 2005 third quarter and year to date interest expense, net included receipts of $0.4 million and $0.8 million, respectively, for interest payments from MD Helicopters, Inc. (MDHI) on past due amounts.

For 2006, the effective income tax rate is 39.5 percent as compared to the effective tax rate of 58.7 percent for 2005. The higher tax rate in 2005 arose principally from the non-deductibility of expenses associated with SARs and with the company’s recapitalization.

Net earnings (loss) for the third quarter of 2006 was $8.7 million, or $0.36 per share diluted, compared to $(3.6) million, or $(.16) per share diluted, for the third quarter of 2005. Net earnings for the first nine months of 2006 were $22.1 million, or $0.91 per share diluted, compared to $3.9 million or $0.17 per share diluted for the first nine months of 2005. The 2006 earnings per share diluted was calculated on a basis of 24.9 million post-recapitalization diluted shares outstanding compared to the 2005 earnings per share diluted which was calculated based on 23.8 million pre-recapitalization diluted shares outstanding. The recapitalization, which was completed in November 2005, diluted the total shares outstanding by 3.6 percent.

AEROSPACE SEGMENT RESULTS

The following table presents selected financial data for the Aerospace segment:

 In millions    
For the three months ended 
   
For the nine months ended 
 
                           
 
   
September 29,
2006 
   
September 30, 2005
   
September 29, 2006
   
September 30, 2005
 
                           
Net sales
 
$
85.4
 
$
70.6
 
$
233.4
 
$
212.4
 
% change
   
20.8
%
 
29.5
%
 
9.9
%
 
17.4
%
                           
Operating income (loss)
 
$
11.8
 
$
(.3
)
$
32.5
 
$
16.8
 
% of net sales
   
13.8
%
 
(.5
)%
 
13.9
%
 
7.9
%
 
Page 25 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued
AEROSPACE SEGMENT

NET SALES

Net sales for the Aerospace segment represented 27.7 percent of total consolidated net sales for the third quarter of 2006 compared to 25.4 percent for the third quarter of 2005. The Aerospace segment represented 26.0 percent of total consolidated net sales for the first nine months of 2006 as compared to 26.1 percent for the first nine months of 2005. This segment has four primary operating units: Aerostructures, Fuzing, Helicopters and the Kamatics subsidiary. The Electro-Optics Development Center (EODC) comprises the remainder of the segment's operating results. In the paragraphs that follow, you will find further information with respect to sales activity and significant programs for the four primary operating units.

AEROSTRUCTURES DIVISION

Net sales for the third quarter of 2006 for the Aerostructures Division increased $6.8 million or 45.9 percent to $21.5 million compared to $14.7 million for the third quarter of 2005. Year to date net sales for 2006 increased $14.3 million or 35.0 percent to $55.4 million compared to $41.1 million for the same period in 2005. The largest driver of the increase in sales is the production of the cockpit for the Sikorsky BLACK HAWK helicopter as well as additional shipments on the Boeing 777 program. These two programs along with the wing structure assembly for the C-17 comprise Aerostructures' major programs.

2006 AEROSTRUCTURES TRENDS

The division continues to work on its multi-year contract with Sikorsky to manufacture cockpits for several models of the BLACK HAWK helicopter. This includes installation of all wiring harnesses, hydraulic assemblies, control pedals and sticks, seat tracks, pneumatic lines, and the composite structure that holds the windscreen. The original order that currently covers approximately 80 cockpits is more than half complete. In the third quarter of 2006, Sikorsky ordered additional cockpits bringing the total contract to an estimated value to date of approximately $38 million. Management estimates that both orders will be fully delivered in mid-2007. This multi-year contract has follow-on options that, if fully exercised, could lead to the fabrication of up to a total of 349 units and bring the total potential value to approximately $100.0 million or more depending upon the models that are ultimately ordered. This program is an important element of the business base at the Jacksonville facility and has continued to provide further opportunities to work with Sikorsky at other Aerospace segment operating units.

At the Jacksonville facility, work proceeded on the production of structural wing sub-assemblies for the C-17, which is currently scheduled to conclude by mid-2007. In August, Boeing informed the company that it anticipates the government ordering an additional 18 aircraft, which could extend the program through 2008.



Page 26 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

Throughout the year, the division has continued to work toward increasing operational efficiencies through process improvement and has begun to benefit from such efforts. We have been steadily increasing our business base at both the Jacksonville facility and our Plastic Fabricating Company (PlasticFab) facility in Wichita. The division continues to focus on recruiting and retaining qualified personnel in order to maintain our current book of business as well as have the capacity for work on new opportunities.

During the third quarter of 2006, PlasticFab shipped its first part to Spirit AeroSystems under its multi-year contract for production of the composite flight deck floor for the Boeing 787 Dreamliner. The contract is valued at approximately $15.0 million. Additionally, management is working diligently to ensure that its new contracts, from Sikorsky involving MH-92 helicopters and Shenyang Aircraft Corporation involving the Boeing 787 Dreamliner, are brought on line effectively in order to meet timing requirements. The first shipments under these programs are anticipated to occur in the fourth quarter of 2006, with production ramping up during 2007.

FUZING DIVISION

Net sales for the third quarter of 2006 for the Fuzing Division increased $5.9 million or 38.7 percent to $21.4 million compared to $15.5 million for the third quarter of 2005. Year to date net sales for 2006 increased $10.0 million or 23.1 percent to $53.2 million compared to $43.2 million for the same period in 2005. The increase in sales for the quarter and for the year is primarily due to higher production volume and shipments at the Middletown, CT facility for both fuzing and memory programs. Year to date 2006, the JPF program at the Dayron facility also experienced sales growth which essentially offset reduced sales as a result of a production interruption on the 40MM programs at the Dayron facility that occurred earlier in the year.

2006 FUZING TRENDS

During the third quarter of 2006, Dayron continued to produce fuzes under its contract with the U.S. Air Force for the advanced FMU-152A/B Joint Programmable Fuze (JPF). The current total value of JPF contracts awarded by the U.S. Government from inception to date is $76.9 million. This primarily consists of Lots 1 through 3 under the original contract and various contract modifications including a two-phase facilitization contract modification, additional foreign military sales facilitated through the U.S. Government, as well as a variety of development and engineering contracts, along with special tooling and test equipment. The Phase 2 facilitization project will result in, among other things, increased production efficiencies and a second site JPF production line at the division's Middletown facility. During the third quarter of 2006, the division continued to work on increasing production efficiencies as well as the ramp up of the second site.

The division has been working through, and has made significant progress with respect to, a variety of issues related to the JPF manufacturing process, which have in the past have resulted in, and may continue to result in, periodic interruptions of program production. The division continues to work on strengthening the reliability of its supply chain and improving material flow on the JPF program in order to meet production requirements. The facilitization program that is currently underway should allow us to improve the quality and efficiency of this program going forward. 

Page 27 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

As the JPF product has continued to develop in the market, the division is focused on further marketing the JPF to foreign militaries. Management believes that foreign sales are an important element in the ultimate success of the program. The JPF is developing into an attractive program and will be further enhanced as improvements continue to be made relative to operating efficiencies, as deliveries to the U.S. military increase and as further orders are received from foreign militaries.

Additionally, the FMU-139 program has been delayed for over a year while our customer works out its technical issue with its customer, the U.S. Government. Management estimates that this issue will be resolved in late 2006 with deliveries on this program extending into 2008.

HELICOPTERS DIVISION

Net sales for the third quarter of 2006 for the Helicopters Division decreased $1.4 million or 8.3 percent to $15.4 million compared to $16.8 million in the same period in 2005. Year to date net sales for 2006 decreased $13.2 million or 23.8 percent to $42.1 million compared to $55.3 million for the same period in 2005. The decrease in the third quarter of 2006 compared to the same period a year ago is primarily due to lower sales related to its SH-2 programs offset by Sikorksy program sales. The decrease in sales for the year to date 2006 compared to the same period in 2005 is primarily driven by the sale of three K-MAX aircraft in the prior year. The Helicopters Division has not sold any K-MAX aircraft during 2006.

2006 HELICOPTERS TRENDS

Work continues on the SH-2G(A) program for Australia, which involves the remanufacture of eleven helicopters with support, including a support services facility, for the RAN. The combined contracts have a current anticipated value of $761.4 million. The helicopter production portion of the program is valued at $611.1 million, essentially all of which has been recorded as sales through the third quarter of 2006. The associated in-service support center contract has a current anticipated value of $150.3 million of which 43.0 percent has been recorded as sales through the third quarter of 2006.

The task of completing the long-delayed SH-2G(A) helicopter program for Australia progressed as Formal Qualification Testing (FQT) on the software for the Integrated Tactical Avionics System (ITAS) continued at the software facilities of our subcontractor, Computer Sciences Corporation (CSC) - Australia, in Sydney. Continued cost growth on this contract has required additional charges to the contract loss reserve including a $2.5 million charge recorded in the third quarter of 2006. Charges recorded for the first nine months of 2006 related to this program total $7.8 million compared to $14.3 million recording during the first nine months of 2005, of which $11.0 million was recorded during the third quarter of 2005. This production contract has been in a loss position since 2002. The remaining accrued contract loss as of the end of the third quarter 2006 is $11.0 million. This contract loss accrual continues to be monitored and adjusted as necessary to reflect the anticipated cost of completing the contract.  


Page 28 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

Concurrently, the company has continued to work with the Royal Australian Navy (RAN) to resolve previously reported flight safety questions that resulted in the grounding of the aircraft earlier this year. There is a significant history of safe and reliable operations with this aircraft type with several nations, including the United States, and the company believes that the cause of the safety concern has been rectified. The RAN also continues to develop additional work scope related to their certification requirements and the division is working with the RAN to address these scope changes. In addition, the company is supporting a previously reported review by the Australian Minister of Defence regarding the possibility of the Commonwealth pursuing an alternative to the Kaman program. The company believes that the current program is the most efficient and cost effective method to achieve the RAN's operational needs and is hopeful that the Commonwealth will confirm its intent to complete the program following receipt of the Minister's recommendations (which is expected in November). Once all of the foregoing items are satisfactorily completed, it is anticipated that the acceptance process for the fully capable helicopter will get underway.

The division is continuing work under a contract to provide depot level maintenance for SH-2G(E) helicopters delivered to the government of Egypt during the 1990s. Currently four aircraft are subject to the contract, which was initially valued at $5.3 million and since increased by approximately $2.0 million for additional work. The first two aircraft have been completed and returned to the customer and work is now underway on the third and fourth aircraft. In addition, in June 2006 the company received a $3.6 million contract from the Naval Air Systems Command (NAVAIR) to provide for long-lead procurement and other work related to planned upgrades to the Egyptian aircraft.

In July 2006, the Helicopters Division received a $3.1 million contract modification from the Army Material Research Development and Engineering Command for follow-on work to the BURRO Unmanned Resupply Helicopter, utilizing the K-MAX. The funding covers work to enhance features of the automatic flight control system and to support BURRO participation in Army demonstrations. Separately, BURRO has been selected to participate in an Army-sponsored demonstration now underway at Ft. Benning, Georgia, during which promising new technologies are being evaluated for rapid introduction into the Army.

The division continues to support K-MAX helicopters that are operating with customers. At the end of the third quarter of 2006, the division maintained $22.9 million of K-MAX inventory, which consisted primarily of spare parts and one aircraft. This inventory continues to be evaluated for any impairment and management believes that its current value represents the lower of cost or market.

KAMATICS

Net sales for both Kamatics and RWG Frankenjura-Industrie Flugwerklager GmbH (the company's German aircraft bearing manufacturer) increased $3.4 million or 14.6 percent to $26.2 million compared to $22.8 million for the third quarter of 2005. Year to date net sales increased $11.2 million or 16.3 percent to $79.8 million compared to $68.6 million for the same period in 2005. The continued sales growth is due to a higher volume of shipments to our commercial jet liner market, the commercial aftermarket, to regional jet makers and commercial engine market.

Page 29 of 45

 
Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

2006 KAMATICS TRENDS

The 2006 year has thus far proven to be a strong year within the aerospace industry in both the commercial and military markets. The outlook continues to remain stable for 2006. Several key customers, including Boeing and Airbus, have been significant contributing factors to the operating results of Kamatics. Kamatics continues to concentrate on maintaining delivery schedules, as well as actively seeking additional sales opportunities and working toward further market penetration. The company’s continued focus on process improvement and enhancing operating efficiencies allows it to manage the additional order activity and backlog. Kamatics is in the process of adding approximately 35,000 square feet of additional capacity at the Bloomfield facility to accommodate the business. Of this, 25,000 square feet was completed and occupied in mid-October 2006, with the remainder scheduled to come on line during the second quarter of 2007.

OPERATING INCOME

The Aerospace segment operating income increased significantly for the third quarter of 2006 compared to the third quarter of 2005. The operating results for the third quarter of 2006 include an Australian program charge of $2.5 million as compared to a charge of $11.0 million recorded during the third quarter of 2005. The significant charge recorded in the third quarter of 2005 essentially offset all of the operating profit generated by the other operating units within the Aerospace segment. Third quarter 2005 results also included a $1.4 million payment from MDHI relating to items that had previously been written off. Third quarter 2006 and 2005 results are net of $0.7 million and $0.6 million, respectively of excess fixed overhead and idle facility costs, primarily related to the Helicopters Division. During the third quarter of 2006, all major operating units in the Aerospace segment, with the exception of the Helicopters Division, generated an increase in operating income compared to 2005. The results for the Helicopters Division, for both periods presented, included significant charges related to the Australia program. Kamatics continued to contribute a significant amount of the segment's operating income while the Aerostructures and Fuzing Divisions also experienced stronger results for the third quarter of 2006.

Operating income for the first nine months of 2006 increased 92.8 percent compared to the first nine months of 2005. Each operating unit within the Aerospace segment generated positive income with the exception of the Helicopters Division that had an operating loss due to a total of $7.8 million of charges recorded for the Australian SH-2G(A) program thus far this year. For the first nine months of 2005, the Helicopters Division had recorded $14.3 million of charges related to this program. Kamatics generated a significant amount of the segment's operating income while both the Aerostructures and Fuzing Divisions experienced a significant increase in operating income during the first nine months of 2006 compared to the same period of 2005. The Aerostructures Division's Jacksonville facility improved operating income is primarily attributable to a broader business base principally as a result of the Sikorsky cockpit program. The Fuzing Divison's Middletown location was the primary driver in its improved operating results, specifically related to a higher volume of shipments of both fuzing and memory products. These results included $2.3 million and $2.0 million of excess fixed overhead and idle facility costs for the first nine months of 2006 and 2005, respectively.


Page 30 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

WARRANTY MATTERS

The company continues to work to resolve two warranty-related matters that primarily impact our FMU-143 program at the Dayron facility. The first issue involves a supplier's recall of a switch embedded in certain bomb fuzes. The second warranty issue involves bomb fuzes manufactured for the U. S. Army utilizing systems which originated before Dayron was acquired by Kaman that have since been found to contain an incorrect part. The net reserve as of the end of the third quarter of 2006 related to these two matters is $1.2 million. This represents management's best estimate of the costs, including re-work, transportation costs and testing, currently expected to be incurred in resolving these matters. Although work continues on these warranty items, there have been delays as the Company responds to ongoing customer input regarding conduct of the work. Management currently anticipates that work will be completed during 2007.

As previously disclosed, in March 2005 the U.S. Attorney's Office for the Middle District of Florida and the Defense Criminal Investigative Service (DCIS) initiated an investigation into the second warranty matter. Dayron has cooperated fully with the authorities, working to resolve the matter in a mutually satisfactory manner. As of the date of this report, the company has not received any notification from the authorities regarding resolution of the investigation. 

OTHER AEROSPACE MATTERS

On July 31, 2006, the company submitted an Offer to Purchase (OTP) to NAVAIR and the General Services Administration for the potential purchase of the portion of the Bloomfield campus that the company currently leases from NAVAIR and has operated for several decades for the principal purpose of performing U.S. government contracts. Management understands that the OTP is proceeding through the U.S. government's formal review process. As of the date of this report, the company has not been notified of any formal action having been taken on the offer and the company anticipates that the process may take several more months. The OTP provides that the company will assume all responsibility for environmental remediation of the facility as necessary to meet Connecticut Department of Environmental Protection (CTDEP) requirements as consideration for transfer of the property. The company would not assume responsibility for the environmental remediation until ownership of the property has been transferred, a process which management estimates could take between three and six months following acceptance of the OTP.

In preparation for disposal of the Moosup, Connecticut facility, CTDEP has given the company conditional approval for reclassification of groundwater in the vicinity of the facility consistent with the character of the area. The company is in the process of connecting neighboring properties to public drinking water in accordance with such approval and in coordination with the CTDEP and local authorities. The company anticipates that this project will be substantially completed in 2006.





Page 31 of 45


Kaman Corporation and Subsidiaries
Part I - Financial Information

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued

INDUSTRIAL DISTRIBUTION SEGMENT RESULTS

The following table presents selected financial data for the Industrial Distribution segment:

 
In millions
   
For the three months ended 
   
For the nine months ended 
 
                           
 
   
September 29,
2006 
   
September 30, 2005
   
September 29, 2006
   
September 30, 2005
 
                           
Net sales
 
$
166.7
 
$
156.5
 
$
507.8
 
$
469.9
 
% change
   
6.6
%
 
4.8
%
 
8.1
%
 
6.7
%
                           
Operating income
 
$
8.5
 
$
5.2
 
$
28.7
 
$
22.1
 
% of net sales
   
5.2
%
 
3.3
%
 
5.6
%
 
4.7
%

NET SALES