KAMN - 9.26.2014 -10-Q

 

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 26, 2014

Or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to ______

Commission File Number: 001-35419

KAMAN CORPORATION

(Exact name of registrant as specified in its charter)

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes           x             No           ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x   Accelerated filer ¨    Non-accelerated filer ¨   Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes         ¨            No          x

At October 24, 2014, there were 27,116,160 shares of Common Stock outstanding.



PART I
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
KAMAN CORPORATION AND SUBSIDIARIES
(In thousands, except share and per share amounts) (Unaudited)
 
 
September 26,
2014
 
December 31,
2013
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
9,760

 
$
10,384

Accounts receivable, net
 
259,035

 
205,873

Inventories
 
379,301

 
390,495

Deferred income taxes
 
25,953

 
30,128

Income tax refunds receivable
 
3,329

 
2,297

Other current assets
 
28,564

 
26,028

Total current assets
 
705,942

 
665,205

Property, plant and equipment, net of accumulated depreciation of $181,431 and $167,282, respectively
 
150,025

 
148,508

Goodwill
 
242,154

 
203,923

Other intangible assets, net
 
98,645

 
89,449

Deferred income taxes
 
6,274

 
10,287

Other assets
 
23,262

 
23,259

Total assets
 
$
1,226,302

 
$
1,140,631

Liabilities and Shareholders’ Equity
 
 

 
 

Current liabilities:
 
 

 
 

Notes payable
 
$
—

 
$
559

Current portion of long-term debt
 
12,500

 
10,000

Accounts payable – trade
 
119,873

 
119,482

Accrued salaries and wages
 
43,501

 
33,677

Advances on contracts
 
1,351

 
9,470

Other accruals and payables
 
53,387

 
54,095

Income taxes payable
 
—

 
673

Total current liabilities
 
230,612

 
227,956

Long-term debt, excluding current portion
 
325,526

 
264,655

Deferred income taxes
 
3,691

 
3,855

Underfunded pension
 
75,495

 
85,835

Other long-term liabilities
 
43,241

 
47,038

Commitments and contingencies (Note 11)
 


 


Shareholders' equity:
 
 

 
 

Preferred stock, $1 par value, 200,000 shares authorized; none outstanding
 
—

 
—

Common stock, $1 par value, 50,000,000 shares authorized; voting; 27,479,386 and 27,189,922 shares issued, respectively
 
27,479

 
27,190

Additional paid-in capital
 
143,615

 
133,517

Retained earnings
 
469,262

 
439,441

Accumulated other comprehensive income (loss)
 
(83,346
)
 
(81,121
)
Less 381,250 and 330,487 shares of common stock, respectively, held in treasury, at cost
 
(9,273
)
 
(7,735
)
Total shareholders’ equity
 
547,737

 
511,292

Total liabilities and shareholders’ equity
 
$
1,226,302

 
$
1,140,631

See accompanying notes to condensed consolidated financial statements.

2

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
KAMAN CORPORATION AND SUBSIDIARIES
(In thousands, except per share amounts) (Unaudited)

 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 26,
2014
 
September 27,
2013
 
September 26, 2014
 
September 27, 2013
Net sales
 
$
462,332

 
$
423,663

 
$
1,335,353

 
$
1,243,463

Cost of sales
 
332,827

 
304,806

 
961,653

 
893,083

Gross profit
 
129,505

 
118,857

 
373,700

 
350,380

Selling, general and administrative expenses
 
103,502

 
87,436

 
298,853

 
274,075

Net loss on sale of assets
 
47

 
—

 
215

 
100

Operating income
 
25,956

 
31,421

 
74,632

 
76,205

Interest expense, net
 
3,444

 
3,113

 
10,060

 
9,344

Other expense (income), net
 
252

 
(21
)
 
541

 
368

Earnings from continuing operations before income taxes
 
22,260

 
28,329

 
64,031

 
66,493

Income tax expense
 
7,387

 
9,634

 
21,507

 
22,752

Earnings from continuing operations
 
14,873

 
18,695

 
42,524

 
43,741

Earnings from discontinued operations, net of taxes
 
(94
)
 
64

 
285

 
64

Gain on disposal of discontinued operations, net of taxes
 
—

 
420

 
—

 
420

Total earnings from discontinued operations, net of taxes
 
(94
)
 
484

 
285

 
484

Net earnings
 
$
14,779

 
$
19,179

 
$
42,809

 
$
44,225

 
 
 
 
 
 
 
 
 
Earnings per share:
 
 

 
 

 
 
 
 
Basic earnings per share from continuing operations
 
$
0.55

 
$
0.70

 
$
1.57

 
$
1.64

Basic earnings per share from discontinued operations
 
—

 
—

 
0.01

 
—

Basic earnings per share from disposal of discontinued operations
 
—

 
0.02

 
—

 
0.02

Basic earnings per share
 
$
0.55

 
$
0.72

 
$
1.58

 
$
1.66

 
 
 
 
 
 
 
 
 
Diluted earnings per share from continuing operations
 
$
0.53

 
$
0.68

 
$
1.53

 
$
1.61

Diluted earnings per share from discontinued operations
 
—

 
—

 
0.01

 
—

Diluted earnings per share from disposal of discontinued operations
 
—

 
0.02

 
—

 
0.02

Diluted earnings per share
 
$
0.53

 
$
0.70

 
$
1.54

 
$
1.63

Average shares outstanding:
 
 

 
 

 
 
 
 
Basic
 
27,113

 
26,770

 
27,025

 
26,721

Diluted
 
27,862

 
27,233

 
27,766

 
27,062

Dividends declared per share
 
$
0.16

 
$
0.16

 
$
0.48

 
$
0.48


See accompanying notes to condensed consolidated financial statements.



3

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
KAMAN CORPORATION AND SUBSIDIARIES
(In thousands) (Unaudited)


 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Net earnings
 
$
14,779

 
$
19,179

 
$
42,809

 
$
44,225

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
(5,766
)
 
4,669

 
(4,306
)
 
(89
)
Unrealized gain (loss) on derivative instruments, net of tax expense (benefit) of $6 and ($74), and $47 and ($36), respectively
 
6

 
(119
)
 
75

 
(58
)
Change in pension and post-retirement benefit plan liabilities, net of tax expense of $405 and $941, and $1,215 and $2,751, respectively
 
669

 
1,536

 
2,006

 
4,487

Other comprehensive income (loss)
 
(5,091
)
 
6,086

 
(2,225
)
 
4,340

Comprehensive income
 
$
9,688

 
$
25,265

 
$
40,584

 
$
48,565


See accompanying notes to condensed consolidated financial statements.


4

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
KAMAN CORPORATION AND SUBSIDIARIES
(In thousands) (Unaudited)
 
 
For the Nine Months Ended
 
 
September 26,
2014
 
September 27,
2013
Cash flows from operating activities:
 
 

 
 

Earnings from continuing operations
 
$
42,524

 
$
43,741

Adjustments to reconcile earnings from continuing operations to net cash provided by (used in) operating activities of continuing operations:
 
 

 
 

Depreciation and amortization
 
26,537

 
23,720

Accretion of convertible notes discount
 
1,439

 
1,366

Provision for doubtful accounts
 
499

 
1,100

Net loss on sale of assets
 
215

 
100

Net loss on derivative instruments
 
615

 
130

Stock compensation expense
 
4,307

 
4,056

Excess tax benefit from share-based compensation arrangements
 
(766
)
 
(350
)
Deferred income taxes
 
7,837

 
2,619

Changes in assets and liabilities, excluding effects of acquisitions/divestitures:
 
 
 
 

Accounts receivable
 
(41,127
)
 
(33,354
)
Inventories
 
19,558

 
(14,269
)
Income tax refunds receivable
 
(1,037
)
 
(3,099
)
Other current assets
 
(1,598
)
 
(1,371
)
Accounts payable - trade
 
(6,009
)
 
(4,814
)
Accrued contract losses
 
(1,613
)
 
(565
)
Advances on contracts
 
(8,119
)
 
16,063

Other accruals and payables
 
11,986

 
(1,762
)
Income taxes payable
 
(712
)
 
(2,263
)
Pension liabilities
 
(8,430
)
 
(5,208
)
Other long-term liabilities
 
(2,637
)
 
(1,016
)
Net cash provided by operating activities of continuing operations
 
43,469

 
24,824

Net cash provided by operating activities of discontinued operations
 
285

 
484

Net cash provided by operating activities
 
43,754

 
25,308

Cash flows from investing activities:
 
 

 
 

Proceeds from sale of assets
 
41

 
111

Expenditures for property, plant & equipment
 
(22,188
)
 
(30,118
)
Acquisition of businesses (net of cash acquired)
 
(77,018
)
 
(19,934
)
Other, net
 
(1,205
)
 
(642
)
Cash used in investing activities of continuing operations
 
(100,370
)
 
(50,583
)
Cash used in investing activities of discontinued operations
 
—

 
—

Cash used in investing activities
 
(100,370
)
 
(50,583
)
Cash flows from financing activities:
 
 

 
 

Net borrowings under revolving credit agreements
 
66,978

 
30,116

Debt repayment
 
(5,000
)
 
(5,000
)
Net change in book overdraft
 
1,893

 
3,617

Proceeds from exercise of employee stock awards
 
5,387

 
4,002

Purchase of treasury shares
 
(845
)
 
(644
)
Dividends paid
 
(12,950
)
 
(12,806
)
Other
 
—

 
(51
)
Windfall tax benefit
 
766

 
350

Cash provided by financing activities of continuing operations
 
56,229

 
19,584

Cash provided by financing activities of discontinued operations
 
—

 
—

Cash provided by financing activities
 
56,229

 
19,584

Net increase (decrease) in cash and cash equivalents
 
(387
)
 
(5,691
)
Effect of exchange rate changes on cash and cash equivalents
 
(237
)
 
150

Cash and cash equivalents at beginning of period
 
10,384

 
16,593

Cash and cash equivalents at end of period
 
$
9,760

 
$
11,052


See accompanying notes to condensed consolidated financial statements.

5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)


1. BASIS OF PRESENTATION

The December 31, 2013, Condensed Consolidated Balance Sheet amounts have been derived from the previously audited Consolidated Balance Sheet of Kaman Corporation and subsidiaries (collectively, the “Company”), but do not include all disclosures required by accounting principles generally accepted in the United States of America ("US GAAP"). In the opinion of management, the condensed financial information reflects all adjustments necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. All such adjustments are of a normal recurring nature, unless otherwise disclosed in this report. 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, 2013. 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.

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 2014 and 2013 ended on September 26, 2014, and September 27, 2013, respectively.

2. RECENT ACCOUNTING STANDARDS

In August 2014, the FASB issued ASU No. 2014-15, "Presentation of Financial Statements - Going Concern (ASC Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern." The new standard provides guidance around management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's financial statements.

In June 2014, the FASB issued ASU No. 2014-12, "Compensation - Stock Compensation (ASC Topic 718) - Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could Be Achieved after the Requisite Service Period." The objective of this standard update is to eliminate inconsistent practices with regards to the accounting treatment of share-based payment awards. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2015. The Company does not expect these changes to have a material impact on its consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (ASC Topic 606)." The objective of this standard update is to remove inconsistent practices with regards to revenue recognition between US GAAP and International Financial Reporting Standards ("IFRS"). The standard intends to improve comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2016; early adoption is not permitted. The Company is currently assessing the potential impact of this ASU on its consolidated financial statements.

In April 2014, the FASB issued ASU No. 2014-08, "Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." This standard update requires that a disposal representing a strategic shift that has (or will have) a major effect on an entity's financial results or a business activity classified as held for sale should be reported as discontinued operations. The standard also expands the disclosures for discontinued operations and requires new disclosures related to individually material disposals that do not meet the definition of a discontinued operation. The provisions of this ASU are effective for interim and annual periods beginning after December 15, 2014. The Company does not expect these changes to have a material impact on its consolidated financial statements.

In July 2013, the FASB issued ASU No. 2013-11, "Income Taxes ("ASC Topic 740") - Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." The objective is to end some inconsistent practices with regard to the presentation on the balance sheet of unrecognized tax benefits.The update was effective for financial statement periods beginning after December 15, 2013. The Company adopted this standard beginning January 1, 2014. There was no material impact on the Company's condensed consolidated balance sheet as of September 26, 2014.


6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

2. RECENT ACCOUNTING STANDARDS (CONTINUED)

In March 2013, the FASB issued ASU No. 2013-05, "Foreign Currency Matters ("ASC Topic 830") - Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." The objective is to resolve the diversity in practice with regard to whether ASC Subtopic 810-10, Consolidation - Overall or ASC Subtopic 830-30 Foreign Currency Matters - Translation of Financial Statements, applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity. The update was effective for financial statement periods beginning after December 15, 2013. The Company has adopted this standard beginning January 1, 2014. There was no impact on the Company's condensed consolidated financial statements for the period ended September 26, 2014.

3. DISCONTINUED OPERATIONS

On December 31, 2012, the Company sold substantially all of the assets and liabilities of the Distribution segment's Canadian operations. As a result, the Company has reported the results of operations and financial position of this component as discontinued operations within the condensed consolidated financial statements for all periods presented. For the three months and nine months ended September 26, 2014, the Company recorded earnings (losses) from discontinued operations of $(0.1) million and $0.3 million, respectively. The activity through the nine months ended September 26, 2014, is primarily related to a pension settlement that resulted from the 2012 disposal of the Distribution segment's Canadian operations. For the three months and nine months ended September 27, 2013, the Company recorded earnings from discontinued operations of $0.5 million, which was due to a favorable tax result versus previous estimates and other activity related to the settlement of the closing balance sheet.

4. ACQUISITIONS

On April 25, 2014, the Company acquired specific assets of B.W. Rogers Company and certain affiliated entities ("B.W. Rogers"). Headquartered in Akron, Ohio, B.W. Rogers operated from twenty-one locations in seven states from the Northeast to the Midwest. The acquisition of B.W. Rogers expands the Company's capabilities in both the fluid power and automation and motion control product areas.

This acquisition was accounted for as a business combination. Assets acquired and liabilities assumed were recorded based on their fair values at the date of acquisition. The fair values of assets acquired and liabilities assumed were as follows:
In thousands
 
Cash
$
11

Accounts receivable
13,332

Inventories
9,614

Property, plant and equipment
850

Other tangible assets
784

Goodwill
37,804

Other intangible assets
16,870

Liabilities
(7,367
)
Total of net assets acquired
71,898

Less cash received
(11
)
Total consideration
$
71,887


The Company has paid $71.3 million of the total consideration of $71.9 million for this acquisition through September 26, 2014. The goodwill associated with B.W. Rogers is tax deductible and is the result of expected synergies from combining the operations of the acquired business with the Company's operations and intangible assets that do not qualify for separate recognition, such as an assembled workforce. Included in the Condensed Consolidated Statements of Operations is $28.5 million and $47.3 million of revenue from this acquisition for the three months and nine months ended September 26, 2014.


7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)


4. ACQUISITIONS (CONTINUED)

The fair values of the identifiable intangible assets, which totaled $16.9 million and consisted of customer relationships, non-compete agreements and trade names, were determined using the income approach. Specifically, the discounted cash flows method was utilized for customer relationships and non-compete agreements and the relief-from-royalty method was utilized for the trade names. The fair value of the customer relationships ($14.9 million) is broken out into two asset categories, which are amortized on a straight-line basis over periods of 11 and 18 years; the fair value of the non-compete agreements ($1.1 million) is being amortized over periods ranging from 1.5 to 3 years; and the fair value of the trade names ($0.9 million) is being amortized over a period of 8 years, the estimated lives of the assets.

During the third quarter of 2014, the Company acquired a smaller distribution business that operates in the fluid power market as a Parker distributor of pneumatic and hydraulic fluid power and motion control systems. Proforma results of operations have not been presented because the effects of the acquisition were not material.

5. ACCOUNTS RECEIVABLE, NET

Accounts receivable, net consists of the following:
 
 
September 26,
2014
 
December 31,
2013
In thousands
 
 
 
 
Trade receivables
 
$
159,702

 
$
125,092

U.S. Government contracts:
 
 

 
 

Billed
 
14,717

 
14,364

Costs and accrued profit – not billed
 
4,287

 
6,340

Commercial and other government contracts:
 
 

 
 

Billed
 
55,472

 
63,051

Costs and accrued profit – not billed
 
29,006

 
853

Less allowance for doubtful accounts
 
(4,149
)
 
(3,827
)
Accounts receivable, net
 
$
259,035

 
$
205,873


Accounts receivable, net includes amounts for matters such as contract changes, negotiated settlements and claims for unanticipated contract costs. These amounts are as follows:
 
 
September 26,
2014
 
December 31,
2013
In thousands
 
 
 
 
Contract changes, negotiated settlements and claims for unanticipated contract costs
 
$
—

 
$
1,021

Total
 
$
—

 
$
1,021


6. FAIR VALUE MEASUREMENTS

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.


8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

6. FAIR VALUE MEASUREMENTS (CONTINUED)

The Company uses a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: 
•
Level 1 — Quoted prices in active markets for identical assets or liabilities.
•
Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data.
•
Level 3 — Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The following table presents the carrying value and fair value of financial instruments that are not carried at fair value:
 
 
September 26, 2014
 
December 31, 2013
 
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
In thousands
 
 
 
 
 
 
 
 
Long-term debt:
 
 
 
 
 
 
 
 
Level 1
 
$
108,531

 
$
147,550

 
$
107,093

 
$
147,822

Level 2
 
229,495

 
217,924

 
167,562

 
155,473

Total
 
$
338,026

 
$
365,474

 
$
274,655

 
$
303,295


The above fair values were computed based on quoted market prices (Level 1) and discounted future cash flows (Level 2 observable inputs), as applicable. Differences from carrying values are attributable to interest rate changes subsequent to when the transaction occurred. The increase in fair value of the long-term debt is driven by increased borrowings under the Company's Revolving Credit Facility.

The fair values of Cash and cash equivalents, Accounts receivable, net, Notes payable, and Accounts payable - trade approximate their carrying amounts due to the short-term maturities of these instruments.

Recurring Fair Value Measurements

The table below segregates all financial assets and liabilities that are measured at fair value on a recurring basis (at least annually) into the most appropriate level within the fair value hierarchy based on the inputs used to determine their fair value at the measurement date:
 
Total Carrying
Value at
 
Quoted prices in
active markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
September 26,
2014
 
 
 
In thousands
 
 
 
 
 
 
 
Derivative instruments
$
38

 
$
—

 
$
38

 
$
—

Total assets
$
38

 
$
—

 
$
38

 
$
—

 
 
 
 
 
 
 
 
Derivative instruments
$
435

 
$
—

 
$
435

 
$
—

Total liabilities
$
435

 
$
—

 
$
435

 
$
—



9
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

6. FAIR VALUE MEASUREMENTS (CONTINUED)

Recurring Fair Value Measurements - continued
 
Total Carrying
Value at
 
Quoted prices in
active markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
December 31,
2013
 
 
 
In thousands
 
 
 
 
 
 
 
Derivative instruments
$
127

 
$
—

 
$
127

 
$
—

Total assets
$
127

 
$
—

 
$
127

 
$
—

 
 
 
 
 
 
 
 
Derivative instruments
$
276

 
$
—

 
$
276

 
$
—

Total liabilities
$
276

 
$
—

 
$
276

 
$
—


The Company’s derivative instruments are foreign exchange contracts and interest rate swaps that are measured at fair value using observable market inputs such as forward rates and our counterparties’ credit risks. Based on these inputs, the derivative instruments are classified within Level 2 of the valuation hierarchy and have been included in other current assets, other assets, other accruals and payables and other long-term liabilities on the Condensed Consolidated Balance Sheets at September 26, 2014, and December 31, 2013. Based on the continued ability to trade and enter into forward contracts, we consider the markets for our fair value instruments to be active.

The Company evaluated the credit risk associated with the counterparties to these derivative instruments and determined that as of September 26, 2014, such credit risks have not had an adverse impact on the fair value of these instruments.

7. DERIVATIVE FINANCIAL INSTRUMENTS

Derivatives Overview

The Company is exposed to certain risks relating to its ongoing business operations, including market risks relating to fluctuations in foreign currency exchange rates and interest rates. Derivative financial instruments are recognized on the Condensed Consolidated Balance Sheets as either assets or liabilities and are measured at fair value. Changes in the fair values of derivatives are recorded each period in earnings or accumulated other comprehensive income, depending on whether a derivative is effective as part of a hedged transaction. Gains and losses on derivative instruments reported in accumulated other comprehensive income are subsequently included in earnings in the periods in which earnings are affected by the hedged item. The Company does not use derivative instruments for speculative purposes.

The Company holds forward exchange contracts designed to hedge forecasted transactions denominated in foreign currencies and to minimize the impact of foreign currency fluctuations on the Company’s earnings and cash flows. Some of these contracts are designated as cash flow hedges. The Company will include in earnings amounts currently included in accumulated other comprehensive income upon recognition of cost of sales related to the underlying transaction. There was $0.2 million and $0.5 million of expense reclassified from other comprehensive income during the three months and nine months ended September 26, 2014, respectively. No material amounts were reclassified to expense from other comprehensive income during the three months and nine months ended September 27, 2013. Over the next twelve months, the expense related to cash flow hedges expected to be reclassified from other comprehensive income is $0.6 million.


10
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

7. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)

Derivatives Designated as Cash Flow Hedges

The Term Loan Facility of the Company's Credit Agreement (“Term Loan”) contains floating rate obligations and is subject to interest rate fluctuations. During 2013, the Company entered into interest rate swap agreements for the purposes of hedging the eight quarterly variable-rate interest payments under its Term Loan due in 2014 and 2015. These interest rate swap agreements were designated as cash flow hedges and are intended to manage interest rate risk associated with the Company’s variable rate borrowings and minimize the impact on the Company’s earnings and cash flows of interest rate fluctuations attributable to changes in LIBOR rates.

During the second quarter of 2014, the Company entered into forward exchange contracts designed to hedge forecasted transactions denominated in foreign currencies and to minimize the impact of foreign currency fluctuations on the Company's earnings and cash flows. These contracts were entered into as a result of forecasted foreign currency transactions associated with the New Zealand contract to deliver ten SH-2G(I) aircraft and were designated as cash flow hedges. During the third quarter of 2014, the Company dedesignated these forward contracts, due to a change in the timing of payments.

The following table shows the fair value of derivative instruments designated as cash flow hedging instruments:
 
 
 
 
Fair Value
 
 
 
 
Balance Sheet
Location
 
September 26,
2014
 
December 31,
2013
 
Notional
Amount
In thousands
 
 
 
 
 
 
 
 
Derivative Liabilities
 
 
 
 
 
 
 
 
Interest rate swap contracts
 
Other liabilities / Other long-term liabilities
 
$
234

 
$
276

 
$86,250 / $90,000
Foreign exchange contracts
 
Other liabilities
 
150

 
—

 
2,626 / 0 AUD
Total
 
 
 
$
384

 
$
276

 
 

The loss recognized in other comprehensive income for derivatives designated as hedge instruments was $0.2 million and $0.4 million, respectively, for the three months and nine months ended September 26, 2014. The loss recognized in other comprehensive income for derivatives designated as hedge instruments was $0.3 million and $0.2 million, respectively, for the three months and nine months ended September 27, 2013.

Derivatives Not Designated as Hedging Instruments

The following table shows the fair value of derivative instruments not designated as hedging instruments:
 
 
 
 
Fair Value
 
 
 
 
Balance Sheet
 
September 26,
 
December 31,
 
Notional
 
 
Location
 
2014
 
2013
 
Amount
In thousands
 
 
 
 
 
 
 
 
Derivative Assets
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
Other current assets
 
$
38

 
$
127

 
$1,212 / $2,349
Total
 
 
 
$
38

 
$
127

 
 
Derivative Liabilities
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
Other liabilities
 
51

 
—

 
£650 / £0
Total
 
 
 
$
51

 
$
—

 
 

The amounts of the gain or (loss) recognized on the Condensed Consolidated Statements of Operations for derivatives not designated as hedge instruments were not material for the three months and nine months ended September 26, 2014 and September 27, 2013.



11
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

8. INVENTORIES

Inventories consist of the following:
 
 
September 26,
2014
 
December 31,
2013
In thousands
 
 
 
 
Merchandise for resale
 
$
152,348

 
$
152,194

Raw materials
 
22,600

 
20,609

Contracts and other work in process
 
192,999

 
205,220

Finished goods (including certain general stock materials)
 
11,354

 
12,472

Total
 
$
379,301

 
$
390,495


Inventories include amounts associated with matters such as contract changes, negotiated settlements and claims for unanticipated contract costs. These amounts are as follows:
 
 
September 26,
2014
 
December 31,
2013
In thousands
 
 
 
 
Contract changes, negotiated settlements and claims for unanticipated contract costs
 
$
9,308

 
$
11,581

Total
 
$
9,308

 
$
11,581


The reduction in this balance is due to the settlement of a claim related to a commercial composite structures program.

K-MAX® inventory of $18.0 million and $17.0 million as of September 26, 2014, and December 31, 2013, respectively, is included in contracts and other work in process inventory and finished goods. Management believes that a significant portion of this K-MAX® inventory will be sold after September 26, 2015, based upon the anticipation of supporting the fleet for the foreseeable future.

At September 26, 2014, and December 31, 2013, $30.7 million and $43.8 million, respectively, of SH-2G(I), formerly SH-2G(A), inventory was included on the Company's balance sheet in contracts and other work in process inventory. On May 8, 2013, the Company announced that it had entered into a $120.6 million contract with the New Zealand Ministry of Defence for the sale of ten SH-2G(I) Super Seasprite aircraft, spare parts, a full mission flight simulator, and related logistics support. Although a substantial portion of the SH-2G(I) inventory will be used in the performance of this contract, management believes that $6.5 million of the SH-2G(I) inventory will be sold after September 26, 2015, based upon the time needed to prepare the aircraft for sale and the requirements of our customer.

Long-term Contracts

For long-term aerospace contracts, the Company generally recognizes revenue and cost based on the percentage-of-completion method of accounting, which allows for recognition of revenue as work on a contract progresses. The Company recognizes revenues and cost based on either (1) the cost-to-cost method, in which sales and profit are recorded based upon the ratio of costs incurred to estimated total costs to complete the contract, or (2) the units-of-delivery method, in which sales are recognized as deliveries are made and cost of sales is computed on the basis of the estimated ratio of total cost to total sales.


12
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

8. INVENTORIES (CONTINUED)

Long-term Contracts - continued

Revenue and cost estimates for all significant long-term contracts for which revenue is recognized using the percentage-of-completion method of accounting are reviewed and reassessed quarterly. Based upon these reviews, the Company records the effects of adjustments in profit estimates each period. If at any time the Company determines that in the case of a particular contract total costs will exceed total contract revenue, the Company will record a provision for the entire anticipated contract loss at that time. There was a net increase to the Company's operating income from changes in contract estimates of $1.3 million and $1.5 million, respectively, for the three-month and nine-month periods ended September 26, 2014. The increases were primarily a result of improved performance on the New Zealand SH-2G(I) program, the Joint Programmable Fuze ("JPF") program and a mix of other legacy fuze and composite programs. These improvements were slightly offset by cost growth on the Sikorsky BLACK HAWK helicopter program and Boeing A-10 program. There was a net decrease to the Company's operating income from changes in contract estimates of $0.1 million and $2.8 million, respectively, for the three-month and nine-month periods ended September 27, 2013. These decreases were a result of cost growth due to revised estimates in various programs, including the Sikorsky BLACK HAWK helicopter program, Bell helicopter offload program and a fuze program.

9. GOODWILL AND OTHER INTANGIBLE ASSETS, NET

Goodwill

The following table sets forth the change in the carrying amount of goodwill for each reportable segment and for the Company:
 
 
Distribution
 
Aerospace
 
Total
In thousands
 
 
 
 
 
 
Gross balance at December 31, 2013
 
$
105,637

 
$
114,538

 
$
220,175

Accumulated impairment
 
—

 
(16,252
)
 
(16,252
)
Net balance at December 31, 2013
 
105,637

 
98,286

 
203,923

Additions
 
38,034

 
1,434

 
39,468

Impairments
 
—

 
—

 
—

Foreign currency translation
 
(21
)
 
(1,216
)
 
(1,237
)
Ending balance at September 26, 2014
 
$
143,650

 
$
98,504

 
$
242,154


Additions to goodwill for the Company's Distribution segment relate to the acquisitions completed during 2014, as set forth in Note 4, Acquisitions. Additions to goodwill for the Company's Aerospace segment relate to an earnout payment associated with a previous acquisition.

Other intangible assets consisted of:
 
 
 
 
At September 26,
 
At December 31,
 
 
 
 
2014
 
2013
 
 
Amortization
Period
 
Gross
Amount
 
Accumulated
Amortization
 
Gross
Amount
 
Accumulated
Amortization
In thousands
 
 
 
 
 
 
 
 
 
 
Customer lists / relationships
 
6-21 years
 
$
124,818

 
$
(30,249
)
 
$
109,790

 
$
(23,647
)
Trademarks / trade names
 
3-8 years
 
3,564

 
(1,970
)
 
2,695

 
(1,594
)
Non-compete agreements and other
 
1-9 years
 
7,206

 
(4,844
)
 
6,133

 
(4,055
)
Patents
 
17 years
 
523

 
(403
)
 
523

 
(396
)
Total
 
 
 
$
136,111

 
$
(37,466
)
 
$
119,141

 
$
(29,692
)

The changes in other intangible assets are attributable to changes in foreign currency exchange rates and the acquisitions completed during 2014.

13
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

10. PENSION PLANS

Components of net pension cost for the Qualified Pension Plan and Supplemental Employees’ Retirement Plan ("SERP") are as follows:
 
 
For the Three Months Ended
 
 
Qualified Pension Plan
 
SERP
 
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
In thousands
 
 
 
 
 
 
 
 
Service cost for benefits earned during the year
 
$
2,940

 
$
3,587

 
$
64

 
$
85

Interest cost on projected benefit obligation
 
7,208

 
6,399

 
85

 
78

Expected return on plan assets
 
(10,262
)
 
(10,337
)
 
—

 
—

Amortization of prior service cost
 
23

 
25

 
—

 
—

Amortization of net loss
 
1,028

 
2,387

 
23

 
65

Additional amount recognized due to curtailment/settlement
 
—

 
—

 
—

 
—

Net pension cost
 
$
937

 
$
2,061

 
$
172

 
$
228


 
 
For the Nine Months Ended
 
 
Qualified Pension Plan
 
SERP
 
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
In thousands
 
 
 
 
 
 
 
 
Service cost for benefits earned during the year
 
$
8,820

 
$
10,761

 
$
192

 
$
255

Interest cost on projected benefit obligation
 
21,625

 
19,197

 
256

 
233

Expected return on plan assets
 
(30,785
)
 
(31,011
)
 
—

 
—

Amortization of prior service cost
 
68

 
75

 
—

 
—

Amortization of net loss
 
3,085

 
6,968

 
68

 
195

Additional amount recognized due to curtailment/settlement
 
—

 
—

 
—

 
277

Net pension cost
 
$
2,813

 
$
5,990

 
$
516

 
$
960


The following tables show the amounts of contributions made to the Qualified Pension Plan and SERP during each period and the additional contributions the Company expects to make during the remainder of 2014:

Year-to-date contributions:
 
 
Qualified Pension Plan
 
SERP
 
 
As of September 26, 2014
 
As of December 31, 2013
 
As of September 26, 2014
 
As of December 31, 2013
In thousands
 
 
 
 
 
 
 
 
Year-to-date contributions
 
$
10,000

 
$
10,000

 
$
686

 
$
2,291


Expected additional contributions in 2014:
 
 
Qualified Pension Plan
 
SERP
In thousands
 
 
 
 
Expected additional contributions
 
$
—

 
$
133



14
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

11. COMMITMENTS AND CONTINGENCIES

Legal Matters

Wichita Matter

As previously disclosed, the U.S. District Court for the District of Kansas issued a grand jury subpoena in 2011 to Plastic Fabricating Company, Inc. (“PlasticFab”), an indirect wholly owned subsidiary of the Company now known as Kaman Composites - Wichita, Inc., regarding a government investigation of record keeping associated with the manufacture of certain composite parts at PlasticFab's facility located in Wichita, Kansas. On October 21, 2014, the U.S. Attorney's Office for the District of Kansas and PlasticFab entered into a civil settlement agreement, pursuant to which PlasticFab, without admitting any wrongdoing, agreed to pay $0.5 million, all of which was previously accrued. The U.S. Attorney's Office for the District of Kansas has also informed PlasticFab that it is closing its files and will conduct no further investigation relating to this matter.

Other Matters

Revenue Sharing Agreement with the Commonwealth of Australia

Pursuant to the terms of the revenue sharing agreement with the Commonwealth of Australia, the Company was required to share proceeds from the resale of the SH-2G(I) inventory with them. During the third quarter of 2014, the Company settled the revenue sharing agreement with the Commonwealth of Australia and made a final payment of $5.3 million. As a result, no further revenue sharing payments will be due to the Commonwealth of Australia as the Company sells the remainder of the SH-2G(I) inventory. Over the course of the revenue sharing agreement, net of the benefits derived from our hedging arrangements, the Company paid approximately $32.1 million to the Commonwealth of Australia.

Moosup

During the third quarter of 2014, the Company sold its former manufacturing facility in Moosup, Connecticut to TD Development, LLC. In connection with the sale, the Company will contribute $4.0 million in cash to an escrow account over a four-year period to fund environmental remediation work that is expected to be performed on the site. The purchase and sale agreement provides that TD Development is responsible for any costs in excess of the $4.0 million contributed by the Company. The first of these payments, $0.8 million, was made at the closing of the transaction. The Company currently has $3.2 million accrued that represents the remainder due to TD Development.

New Hartford

In connection with the sale of the Company’s Music segment in 2007, the Company assumed responsibility for meeting certain requirements of the Connecticut Transfer Act (the “Transfer Act”) that applied to the transfer of the New Hartford, Connecticut, facility leased by that segment for guitar manufacturing purposes (“Ovation”). Under the Transfer Act, those responsibilities essentially consist of assessing the site's environmental conditions and remediating environmental impairments, if any, caused by Ovation's operations prior to the sale. The site is a multi-tenant industrial park, in which Ovation and other unrelated entities lease space. The environmental assessment process, which began in 2008, has been completed.

The Company's estimate of its portion of the cost to assess the environmental conditions and remediate this site is $2.2 million, unchanged from the previously reported estimate, all of which has been accrued. The total amount paid to date in connection with these environmental remediation activities is $0.5 million. A portion ($0.6 million) of the accrual related to this property is included in other accruals and payables and the balance is included in other long-term liabilities. The remaining balance of the accrual reflects the total anticipated cost of completing these environmental remediation activities. Although it is reasonably possible that additional costs will be paid in connection with the resolution of this matter, the Company is unable to estimate the amount of such additional costs, if any, at this time.


15
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

11. COMMITMENTS AND CONTINGENCIES (CONTINUED)

Other Matters - continued

Bloomfield

In connection with the Company’s 2008 purchase of the portion of the Bloomfield campus that a Company subsidiary had leased from the Naval Air Systems Command (NAVAIR), the Company assumed responsibility for environmental remediation at the facility as may be required under the Transfer Act and continues the effort to define the scope of the remediation that will be required by the Connecticut Department of Energy & Environmental Protection. The assumed environmental liability of $10.3 million, all of which has been accrued, was determined by taking the undiscounted estimated remediation liability of $20.8 million and discounting it at a rate of 8%. This remediation process will take many years to complete. The total amount paid to date in connection with these environmental remediation activities is $8.5 million. At September 26, 2014, the Company has $5.8 million accrued for this environmental matter. A portion ($1.6 million) of the accrual related to this property is included in other accruals and payables, and the balance ($4.2 million) is included in other long-term liabilities. Although it is reasonably possible that additional costs will be paid in connection with the resolution of this matter, the Company is unable to estimate the amount of such additional costs, if any, at this time.

United Kingdom

In connection with the purchase of the Company's U.K. composites business operations, the Company accrued £1.6 million for environmental compliance at the acquired facilities. The remaining balance of the accrual at September 26, 2014, was £0.3 million, with £1.1 million having been paid to date in connection with these environmental remediation activities and £0.2 million released to income in 2011. The U.S. dollar equivalent of the remaining environmental compliance liability as of September 26, 2014, is $0.5 million, which is included in other accruals and payables. The Company continues to assess the work that may be required, which may result in a change to this accrual. Although it is reasonably possible that additional costs will be paid in connection with the resolution of this matter, the Company is unable to estimate the amount of such additional costs, if any, at this time.

Other Environmental Matters

The Company has been notified by the Environmental Protection Agency that it is a potentially responsible party ("PRP") at a Superfund Site. At September 26, 2014, the Company had no amount accrued for this matter, as it is unable to estimate the amount of costs, if any, that might be incurred in connection with the remediation of this site. In making this determination, the Company considered all available information related to the site; specifically, the continued identification of PRPs and the inability to determine the proportion of total responsibility attributable to each PRP at this time. As more information is received, the Company will reassess its ability to estimate its portion of the cost for remediation, taking into consideration the financial resources of other PRPs involved in the site, their proportionate share of the total responsibility for waste at the site, the existence of insurance and the financial viability of the insurer.


16
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

12. COMPUTATION OF EARNINGS PER SHARE

The computation of basic earnings per share is based on net earnings divided by the weighted average number of shares of common stock outstanding for each period. The computation of diluted earnings per share reflects the common stock equivalency of dilutive options granted to employees under the Company's stock incentive plan and shares issuable on redemption of its Convertible Notes.
   
 
For the Three Months Ended
 
For the Nine Months Ended
  
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
In thousands, except per share amounts
 
 
 
 
 
 
 
 
Earnings from continuing operations
 
$
14,873

 
$
18,695

 
$
42,524

 
$
43,741

Earnings from discontinued operations, net of tax
 
(94
)
 
64

 
285

 
64

Gain on disposal of discontinued operations, net of tax
 
—

 
420

 
—

 
420

Net earnings
 
$
14,779

 
$
19,179

 
$
42,809

 
$
44,225

 
 
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
 
Weighted average number of shares outstanding
 
27,113

 
26,770

 
27,025

 
26,721

 
 
 
 
 
 
 
 
 
Earnings per share from continuing operations
 
$
0.55

 
$
0.70

 
$
1.57

 
$
1.64

Earnings per share from discontinued operations
 
—

 
—

 
0.01

 
—

Earnings per share from disposal of discontinued operations
 
—

 
0.02

 
—

 
0.02

Basic earnings per share
 
$
0.55

 
$
0.72

 
$
1.58

 
$
1.66

Diluted:
 
 

 
 

 
 
 
 
Weighted average number of shares outstanding
 
27,113

 
26,770

 
27,025

 
26,721

Weighted average shares issuable on exercise of dilutive stock options
 
142

 
164

 
152

 
156

Weighted average shares issuable on redemption of convertible notes
 
607

 
299

 
589

 
185

Total
 
27,862

 
27,233

 
27,766

 
27,062

 
 
 
 
 
 
 
 
 
Earnings per share from continuing operations
 
$
0.53

 
$
0.68

 
$
1.53

 
$
1.61

Earnings per share from discontinued operations
 
—

 
—

 
0.01

 
—

Earnings per share from disposal of discontinued operations
 
—

 
0.02

 
—

 
0.02

Diluted earnings per share
 
$
0.53

 
$
0.70

 
$
1.54

 
$
1.63


Equity awards

For the three and nine months ended September 26, 2014, respectively, 310,192 and 356,841 shares issuable under equity awards granted to employees were excluded from the calculation of diluted earnings per share as they were anti-dilutive based on the average stock price during the period. For the three and nine months ended September 27, 2013, respectively, 405,505 and 429,541 shares issuable under equity awards granted to employees were excluded from the calculation of diluted earnings per share as they were anti-dilutive based on the average stock price during the period.

Convertible Notes

In November 2010, the Company issued Convertible Notes due on November 15, 2017, in the aggregate principal amount of $115.0 million. The Convertible Notes will mature on November 15, 2017, unless earlier redeemed, repurchased by the Company or converted. Upon conversion, the Convertible Notes require net share settlement, where the aggregate principal amount of the notes will be paid in cash and remaining amounts due, if any, will be settled in cash, shares of the Company's common stock or a combination of cash and shares of common stock, at the Company's election.

17
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

12. COMPUTATION OF EARNINGS PER SHARE (CONTINUED)

For the three-month and nine-month periods ended September 26, 2014, and September 27, 2013, shares issuable under the Convertible Notes that were dilutive during the period were included in the calculation of earnings per share as the conversion price for the Convertible Notes was less than the average share price of the Company's stock.

Warrants

Excluded from the diluted earnings per share calculation for the three months and nine months ended September 26, 2014, are 3,412,339 and 3,410,690, respectively, shares issuable under the warrants sold in connection with the Company’s convertible note offering as they would be anti-dilutive. For the three and nine months ended September 27, 2013, respectively, 3,405,585 and 3,403,710, shares issuable under the warrants sold in connection with the Company’s convertible note offering were excluded from the diluted earnings per share calculation as they would be anti-dilutive.

13. SHARE-BASED ARRANGEMENTS

General

The Company accounts for stock options, restricted stock awards, restricted stock units and performance shares as equity awards and measures the cost of all share-based payments, including stock options, at fair value on the grant date and recognizes this cost in the statement of operations. The Company also has an employee stock purchase plan which is accounted for as a liability award.

Compensation expense for stock options, restricted stock awards and restricted stock units is recognized on a straight-line basis over the vesting period of the awards. Share-based compensation expense recorded for the three-month and nine-month periods ended September 26, 2014, was $1.0 million and $4.3 million, respectively. Share-based compensation expense recorded for the three-month and nine-month periods ended September 27, 2013, was $1.0 million and $4.1 million, respectively.

During the first quarter of 2014, the Company issued stock awards totaling 10,934 shares with market and performance based conditions. The Company measured the cost of these awards based on their fair value at the date of grant to the extent of the probable number of shares to be earned upon vesting. Amortization of this cost will be recorded on a straight-line basis over the requisite service period. Throughout the course of the requisite service period, the Company will monitor the level of achievement compared to the target and adjust the number of shares expected to be earned, and the related compensation expense recorded thereafter, to reflect the updated most probable outcome. Compensation expense for these awards for the three months and nine months ended September 26, 2014, was not material.

Stock option activity was as follows:
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 26, 2014
 
September 26, 2014
 
 
Options
 
Weighted - average
exercise price
 
Options
 
Weighted - average
exercise price
Options outstanding at beginning of period
 
932,812

 
$
31.05

 
891,932

 
$
28.18

Granted
 
—

 
$
—

 
186,885

 
$
39.22

Exercised
 
(4,086
)
 
$
13.97

 
(144,146
)
 
$
23.28

Forfeited or expired
 
(5,536
)
 
$
36.77

 
(11,481
)
 
$
35.68

Options outstanding at September 26, 2014
 
923,190

 
$
31.09

 
923,190

 
$
31.09



18
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

13. SHARE-BASED ARRANGEMENTS (CONTINUED)

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 Nine Months Ended
 
 
September 26,
2014
 
September 27,
2013
Expected option term (years)
 
5.1

 
5.2

Expected volatility
 
37.5
%
 
45.5
%
Risk-free interest rate
 
1.5
%
 
0.9
%
Expected dividend yield
 
1.7
%
 
2.0
%
Per share fair value of options granted
 
$
11.60

 
$
12.38


There were no options granted for the three-month periods ended September 26, 2014, and September 27, 2013.

Restricted Stock Award and Restricted Stock Unit activity was as follows:
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 26, 2014
 
September 26, 2014
 
 
Restricted  Stock
 
Weighted-
average grant
date fair value
 
Restricted  Stock
 
Weighted-
average grant
date fair value
Restricted Stock outstanding at beginning of period
 
208,438

 
$
36.27

 
188,647

 
$
31.83

Granted
 
—

 
$
—

 
111,071

 
$
39.89

Vested
 
(100
)
 
$
23.75

 
(84,354
)
 
$
31.63

Forfeited or expired
 
(9,765
)
 
$
36.58

 
(16,791
)
 
$
33.49

Restricted Stock outstanding at September 26, 2014
 
198,573

 
$
36.28

 
198,573

 
$
36.28


14. SEGMENT AND GEOGRAPHIC INFORMATION

The Company is organized based upon the nature of its products and services, and is composed of two operating segments each overseen by a segment manager.  These segments are reflective of how the Company’s Chief Executive Officer, who is its Chief Operating Decision Maker (“CODM”), reviews operating results for the purposes of allocating resources and assessing performance. The Company has not aggregated operating segments for purposes of identifying reportable segments.

The Distribution segment is a leading power transmission, motion control, and fluid power industrial distributor with operations throughout the United States and Mexico. Distribution conducts business in the mechanical power transmission and bearings, electrical, automation and control, and fluid power product platforms and provides total solutions from system design and integration to machine parts and value-added services to North America's manufacturing industry.

The Aerospace segment produces and/or markets widely used proprietary aircraft bearings and components; complex metallic and composite aerostructures for commercial, military and general aviation fixed and rotary wing aircraft; safe and arm solutions for missile and bomb systems for the U.S. and allied militaries; subcontract helicopter work; support for the Company’s SH-2G Super Seasprite maritime helicopters and K-MAX® medium-to-heavy lift helicopters; and engineering services.


19
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

14. SEGMENT AND GEOGRAPHIC INFORMATION (CONTINUED)

Summarized financial information by business segment is as follows:
 
 
For the Three Months Ended
 
For the Nine Months Ended
In thousands
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
Net sales:
 
 
 
 
 
 
 
 
Distribution
 
$
308,571

 
$
272,951

 
$
877,627

 
$
800,352

Aerospace
 
153,761

 
150,712

 
457,726

 
443,111

Net sales
 
$
462,332

 
$
423,663

 
$
1,335,353

 
$
1,243,463

Operating income:
 
 

 
 

 
 
 
 
Distribution
 
$
13,272

 
$
14,675

 
$
39,826

 
$
32,974

Aerospace
 
26,813

 
27,638

 
75,515

 
77,227

Net loss on sale of assets
 
(47
)
 
—

 
(215
)
 
(100
)
Corporate expense
 
(14,082
)
 
(10,892
)
 
(40,494
)
 
(33,896
)
Operating income from continuing operations
 
25,956

 
31,421

 
74,632

 
76,205

Interest expense, net
 
3,444

 
3,113

 
10,060

 
9,344

Other expense (income), net
 
252

 
(21
)
 
541

 
368

Earnings before income taxes from continuing operations
 
22,260

 
28,329

 
64,031

 
66,493

Income tax expense
 
7,387

 
9,634

 
21,507

 
22,752

Earnings from continuing operations
 
$
14,873

 
$
18,695

 
$
42,524

 
$
43,741


The Company's Distribution segment acquired the operating assets of B.W. Rogers during the second quarter of 2014. This acquisition resulted in an increase to the segment's total assets, as compared to December 31, 2013.

 
September 26, 2014
 
December 31, 2013
In thousands
 
 
 
Identifiable assets:
 
 
 
Distribution
$
573,680

 
$
480,117

Aerospace
560,059

 
557,831

Corporate
92,563

 
102,683

Total assets
$
1,226,302

 
$
1,140,631



15. SHAREHOLDERS' EQUITY AND ACCUMULATED OTHER COMPREHENSIVE INCOME

Changes in shareholders’ equity for the nine months ended September 26, 2014, and September 27, 2013, respectively, were as follows:
 
 
For the Nine Months Ended
 
 
September 26, 2014
 
September 27, 2013

In thousands
 
 
 
 
Beginning balance
 
$
511,292

 
$
420,193

Comprehensive income
 
40,584

 
48,565

Dividends declared
 
(12,988
)
 
(12,834
)
Employee stock plans and related tax benefit
 
5,387

 
4,002

Purchase of treasury shares
 
(845
)
 
(644
)
Share-based compensation expense
 
4,307

 
4,056

Ending balance
 
$
547,737

 
$
463,338


20
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)


15. SHAREHOLDERS' EQUITY AND ACCUMULATED OTHER COMPREHENSIVE INCOME (CONTINUED)

The components of accumulated other comprehensive income (loss) are shown below:
 
 
For the Three Months Ended
 
 
September 26, 2014
 
September 27, 2013
In thousands
 
 
 
 
Foreign currency translation:
 
 
 
 
Beginning balance
 
$
(12,759
)
 
$
(21,273
)
Net gain/(loss) on foreign currency translation
 
(5,766
)
 
4,669

Reclassification to net income
 
—

 
—

Other comprehensive income/(loss), net of tax
 
(5,766
)
 
4,669

Ending balance
 
$
(18,525
)
 
$
(16,604
)
 
 
 
 
 
Pension and other post-retirement benefits(a):
 
 
 
 
Beginning balance
 
(64,980
)
 
(101,600
)
Reclassification to net income
 
 
 
 
Amortization of prior service cost, net of tax expense of $9 and $10, respectively
 
14

 
15

Amortization of net loss, net of tax expense of $396 and $931, respectively
 
655

 
1,521

Other comprehensive income/(loss), net of tax
 
669

 
1,536

Ending balance
 
$
(64,311
)
 
$
(100,064
)
 
 
 
 
 
Derivative instruments(b):
 
 
 
 
Beginning balance
 
(516
)
 
(463
)
Net loss on derivative instruments, net of tax benefit of $62 and $98, respectively
 
(104
)
 
(158
)
Reclassification to net income, net of tax expense of $68 and $24, respectively
 
110

 
39

Other comprehensive income/(loss), net of tax
 
6

 
(119
)
Ending balance
 
$
(510
)
 
$
(582
)
 
 
 
 
 
Total accumulated other comprehensive income (loss)
 
$
(83,346
)
 
$
(117,250
)


21
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)


15. SHAREHOLDERS' EQUITY AND ACCUMULATED OTHER COMPREHENSIVE INCOME (CONTINUED)
 
 
For the Nine Months Ended
 
 
September 26, 2014
 
September 27, 2013
In thousands
 
 
 
 
Foreign currency translation:
 
 
 
 
Beginning balance
 
$
(14,219
)
 
$
(16,515
)
Net gain/(loss) on foreign currency translation
 
(4,306
)
 
(89
)
Reclassification to net income
 
—

 
—

Other comprehensive income/(loss), net of tax
 
(4,306
)
 
(89
)
Ending balance
 
$
(18,525
)
 
$
(16,604
)
 
 
 
 
 
Pension and other post-retirement benefits(a):
 
 
 
 
Beginning balance
 
(66,317
)
 
(104,551
)
Reclassification to net income
 
 
 
 
Amortization of prior service cost, net of tax expense of $26 and $30, respectively
 
42

 
45

Amortization of net loss, net of tax expense of $1,189 and $2,721, respectively
 
1,964

 
4,442

Other comprehensive income/(loss), net of tax
 
2,006

 
4,487

Ending balance
 
$
(64,311
)
 
$
(100,064
)
 
 
 
 
 
Derivative instruments(b):
 
 
 
 
Beginning balance
 
(585
)
 
(524
)
Net loss on derivative instruments, net of tax benefit of $140 and $71, respectively
 
(233
)
 
(114
)
Reclassification to net income, net of tax expense of $187 and $35, respectively
 
308

 
56

Other comprehensive income/(loss), net of tax
 
75

 
(58
)
Ending balance
 
$
(510
)
 
$
(582
)
 
 
 
 
 
Total accumulated other comprehensive income (loss)
 
$
(83,346
)
 
$
(117,250
)

(a) These accumulated other comprehensive income components are included in the computation of net periodic pension cost.
(See Note 10, Pension Plans for additional information.)

(b) See Note 7, Derivative Financial Instruments, for additional information regarding our derivative instruments.

16. INCOME TAXES
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
 
 
 
 
 
 
 
Effective Income Tax Rate
 
33.2
%
 
34.0
%
 
33.6
%
 
34.2
%

The effective income tax rate represents the combined federal, state and foreign tax effects attributable to pretax earnings for the year. The decrease in the effective tax rate for the three-month and nine-month periods ended September 26, 2014, as compared to the rates for the same periods in the prior year is primarily due to a return to provision adjustment recorded during the third quarter.

22
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued
For the three months and nine months ended September 26, 2014 and September 27, 2013
(Unaudited)

17. SUBSEQUENT EVENTS

The Company has evaluated subsequent events through the issuance date of these financial statements. Other than the item noted below, no material subsequent events were identified that required disclosure.

On October 21, 2014, the U.S. Attorney's Office for the District of Kansas and PlasticFab entered into a civil settlement agreement regarding the government's investigation of record keeping associated with the manufacture of certain composite parts at PlasticFab's facility located in Wichita, Kansas. See Note 11, Commitment and Contingencies for additional information.

23

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

This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide readers of our condensed consolidated financial statements with the perspectives of management. It presents, in narrative form, information regarding our financial condition, results of operations, liquidity and certain other factors that may affect our future results, and is designed to enable the readers of this report to obtain a comprehensive understanding of our businesses, strategies, current trends and future prospects. It should be read in conjunction with our 2013 Annual Report on Form 10-K.

OVERVIEW OF BUSINESS

Kaman Corporation (the "Company") is comprised of two business segments:
•
The Distribution segment is a leading power transmission, motion control, electrical and automation, and fluid power industrial distributor with operations throughout the United States and Mexico. We provide products including bearings, mechanical and electrical power transmission, fluid power, motion control, automation, material handling components, electrical control and power distribution, and MRO supplies to a broad spectrum of industrial markets throughout the United States and Mexico.
•
The Aerospace segment produces and/or markets proprietary aircraft bearings and components; complex metallic and composite aerostructures for commercial, military and general aviation fixed and rotary wing aircraft; safe and arming solutions for missile and bomb systems for the U.S. and allied militaries; subcontract helicopter work; support for our SH-2G Super Seasprite maritime helicopters and K-MAX® manned and unmanned medium-to-heavy lift helicopters; and engineering design, analysis and certification services.

Financial performance

•
Net sales from continuing operations increased 9.1% and 7.4% for the three months and nine months ended September 26, 2014, respectively, compared to the comparable periods in the prior year.
•
Earnings from continuing operations decreased 20.4% and 2.8% for the three months and nine months ended September 26, 2014, respectively, compared to the comparable periods in the prior year.
•
Diluted earnings per share from continuing operations decreased to $0.53, a decrease of $0.15, or 22.1% for the three months ended September 26, 2014, compared to the comparable period in the prior year. For the nine months ended September 26, 2014, diluted earnings per share from continuing operations decreased to $1.53, a decrease of $0.08, or 5.0% compared to the comparable period in the prior year.
•
Cash flows provided by operating activities of continuing operations for the nine months ended September 26, 2014, were $43.5 million, $18.6 million more than the comparable period in the prior year.
•
For the three months ended September 26, 2014,our Distribution segment achieved record net sales of $308.6 million.

Significant events

•
The Company announced that it has been awarded an extension to its current Global Outline Agreement (“GOA”) with Bell Helicopters to manufacture skin and skin to core components for a majority of Bell’s commercial helicopter models. This three-year follow on contract has an expected value exceeding $24 million.
•
The Company is currently in negotiations with General Dynamics Canada to remanufacture and upgrade four Kaman SH-2G Super Seasprite aircraft, and will provide support for the operation of a fifth aircraft for the Peruvian Navy.
•
On October 21, 2014, the Company entered into a civil settlement agreement with the U.S. Attorney's Office for the District of Kansas, associated with a matter at its Wichita facility.
•
On September 18, 2014, the Company held its first Investor Day in New York City.
•
On September 12, 2014, the Company announced that its subsidiary, Kaman Aerospace Corporation, sold its former manufacturing facility in Moosup, Connecticut, to TD Development, LLC.
•
During the third quarter of 2014, the Company settled its revenue sharing agreement with the Commonwealth of Australia for $5.3 million.



24

Outlook

We are lowering our sales range at Distribution to $1,185 million to $1,195 million from $1,190 million to $1,220 million and operating income to 4.5% to 4.6% from 4.8% to 5.2%. At Aerospace, we are lowering our sales range to $630 million to $640 million from $640 million to $660 million; however, we are increasing our range for operating income to 16.8% to 17.0% from 16.5% to 16.7%. Additionally, we are lowering our expectations for Corporate Expense to $51 million from $52 million and our tax rate to 34% from 35%. Finally, we have increased our Free Cash Flow(a) expectations for the year by $5.0 million, to $55 million to $60 million. Our updated outlook for 2014 is as follows:

•
Distribution:
◦
Sales of $1,185 million to $1,195 million
◦
Operating margins of 4.5% to 4.6%
•
Aerospace:
◦
Sales of $630 million to $640 million
◦
Operating margins of 16.8% to 17.0%
•
Interest expense of approximately $13.5 million
•
Corporate expense of approximately $51 million, excluding $2.3 million of charges related to the sale of the idle facility in Moosup, CT
•
Estimated annualized tax rate of approximately 34%
•
Depreciation and amortization expense of approximately $38 million
•
Capital expenditures of $30 million to $35 million
•
Free cash flow in the range of $55 million to $60 million

The following table illustrates the calculation of "Free Cash Flow", a Non-GAAP financial measure:
 
2014 Outlook
In millions
 
 
 
Free Cash Flow(a):
 
 
 
     Net cash provided by operating activities
$
85.0

to
$
95.0

     Expenditures for property, plant and equipment
30.0

to
35.0

          Free Cash Flow
$
55.0

to
$
60.0

(a) Free Cash Flow, a non-GAAP financial measure, is defined as net cash provided by operating activities less expenditures for property, plant and equipment, both of which are presented on our consolidated statements of cash flows. See Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-GAAP Financial Measures.

RESULTS OF OPERATIONS

Consolidated Results

Net Sales
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 26,
2014
 
September 27,
2013
 
September 26,
2014
 
September 27,
2013
 
 
(in thousands)
Net sales
 
$
462,332

 
$
423,663

 
$
1,335,353

 
$
1,243,463

$ change
 
38,669

 
14,096

 
91,890

 
49,951

% change
 
9.1
%
 
3.4
%
 
7.4
%
 
4.2
%


25

The following table details the components of the increase in net sales as a percentage of consolidated net sales:
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
 
September 26, 2014
 
September 26, 2014
Organic Sales(1):
 
 
 
 
Distribution
 
1.1
%
 
1.1
%
Aerospace
 
0.7
%
 
1.2
%
Total Organic Sales
 
1.8
%
 
2.3
%
 
 
 
 
 
Sales by Recent Acquisitions:
 
 
 
 
Distribution
 
7.3
%
 
5.1
%
Aerospace
 
—
%
 
—
%
Total Acquisition Sales
 
7.3
%
 
5.1
%
 
 
 
 
 
% change in net sales
 
9.1
%
 
7.4
%
(1) Sales contri