RBC Bearings Incorporated (RBC) Q3 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the RBC Bearings Q3 2016 Earnings Conference Call. [Operator Instructions] As a reminder to our audience, this conference is being recorded. Now I would like to turn the call over to Mike Cummings with the Alpha IR Group. You have the floor, Sir.

Good morning, and thank you for joining us for RBC Bearings Fiscal 2016 Third Quarter Earnings Conference Call. With me on the call today are Dr. Michael J. Hartnett, Chairman, President and Chief Executive Officer; and Daniel A. Bergeron, Vice President and Chief Financial Officer. Before beginning today's call, let me remind you that some of the statements made today will be forward-looking and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected or implied due to a variety of factors. We refer you to RBC Bearings' recent filings with the SEC for a more detailed discussion of the risks that could impact the company's future operating results and financial condition. These factors are also described in greater detail in the press release and on the company's website. In addition, reconciliation between GAAP and non-GAAP financial information is included as part of the release and is available on the company's website. Now I'll turn the call over to Dr. Hartnett.

Thank you, Mike, and good morning, everyone, and welcome. Net sales for our third quarter fiscal 2016 were $144.2 million versus $106.3 million for the same period last year, a 35.6% increase. Our aerospace markets increased 67% on a year-over-year basis, and our industrial markets were down 0.7%. For the third quarter fiscal 2016, sales of industrial products represented 34% of our net sales and aerospace products were at 66%. Adjusted gross margin for the third quarter of fiscal 2016 was $54.1 million or 37.5% compared to $41.7 million or 39.2% for the same period last year. On a year-to-date basis, adjusted gross margin percentage of sales for the third quarter fiscal 2016 was 38% compared to 39% -- 38.9% for the same period last year. The reduction is principally the result of adding the Sargent businesses to the consolidation and a little bit of a mix shift in the RBC core business. We are methodically implementing RBC's manufacturing philosophy and methods into the new facilities and expect to see improving margin performance over the next 3 years. To be specific, the improvement will come from 4 sources: number one, in-sourcing Sargent purchases to RBC's plants; number two, improvement of planning and manufacturing methods at the Sargent plants; number three, mix management through pricing and tailoring; and number four, continued improvements of RBC core gross margins, resulting from maturing projects on process design and methods. Our markets for industrial products saw an expansion of 6.1%, demand was mixed; strong for marine products; steady and slightly up for general industrial products, those are nonoil and gas and mining products; and as expected, weak in the oil gas mining sectors. The oil and mining markets now represent less than 4% of our consolidated revenues. The strategy in this regard is to maintain a state of technical readiness to support increased requirements once these markets inevitably normalize and our allies at Saudis run out of money. In this regard, we continue to work on expanding our offering and creating new patentable designs in these areas. Relative to our aerospace business, sales were up 67% on a year-over-year basis for the quarter. Aerospace OEM was 73.6%, and aerospace distribution and aftermarket increased 38.8%. We are more than pleased with the continuous strength of these markets in our expanding product positions, both in airframe and in engines. During the quarter, we saw strengths from aerospace distribution marketplace and at the end of the quarter, strengthening from the aerospace OEMs. I'll explain our theory on this in a minute. I'm sure everyone has heard the Boeing news on aircraft deliveries calendar year 2015 versus calendar year 2016. In calendar year '15, Boeing delivered 762 aircraft, about the number they built in 2015. And in calendar year '16, they plan to deliver 740 to 745 planes. Today, their skyline chart shows a build rate of 773 planes in calendar year '16 followed by 808 planes in calendar year '17, a 4.5% increase. So although the year-to-year build rate is a little better in calendar '16 versus calendar '15, deliveries are less than production because of certification requirements needed to release the 737 MAX ships, notwithstanding today's Wall Street Journal article on the subject. Another step up in production and delivery is planned for calendar year '18. So as this relates to RBC, our products lead aircraft builds by approximately 6 months. We expect to see the step up in demand for RBC product deliveries in our second quarter beginning July, but, of course, the actual production of the product takes place in our plants, but months sooner. Hence, the demand increases we saw late third quarter as many of these products have a 24- to 30-week lead time. This is because of special materials and extensive certified processing requirements with select vendors. As we see it, demand increase late in the most recent quarterly period was a harbinger of Boeing calendar year '17 production requirements, which is a completely normal occurrence. We expect to see continued strengthening from this sector as both the major plane builders increased production rates, and Airbus brings the A350 to production rate from 15 ships in calendar year '15 to 60 ships in calendar year '17, with the goal of 13 ships per month after 2018. We have considerable content per ship on this aircraft. Airbus rates go from 738 ships in '16 to 820 ships in '17, a 12% increase, driven primarily by the A320neo. So let's talk a little bit about our last fiscal quarter, the January, February and March period that we're in now. As always, this quarter is a big one for us. We are working hard with our new companies on planning, execution, forecasting and consistency. They still have a ways to go to the levels we expect within RBC. With that said, we are expecting to see sales in the fourth quarter in the neighborhood of $159 million to $162 million compared to $113.4 million last year. I'll now turn the call over to Dan who'll provide more details on the financial performance.

Thanks, Mike. SG&A for the third quarter of fiscal 2016 was $23.9 million compared to $19.3 million for the same period last year. As a percentage of net sales, SG&A was 16.5% for the third quarter of fiscal 2016 compared to 18.1% for the same period last year. Excluding the impact of Sargent acquisition of $4.3 million, SG&A year-over-year increased $0.3 million, which was mainly due to $400,000 stock compensation expense, 300,000 -- $200,000 personnel expense and the cost reduction of $300,000. Other operating expenses for the third quarter of fiscal 2016 was expense of $2.6 million compared to expense of $1.8 million for the same period last year. For the third quarter fiscal 2016, other operating expenses were comprised of $2.5 million in amortization of intangibles and $0.1 million in miscellaneous expenses. Operating income was $27.1 million for the third quarter fiscal 2016 compared to operating income of $20.6 million for the same period last year. On an adjusted basis, operating income would have been $27.6 million for the third quarter fiscal 2016 compared to $22.2 million for the same period last year. Adjusted operating income as a percentage of net sales would have been 19.2% for the third quarter of fiscal 2016 compared to 20.9% for the same period last year. For the third quarter fiscal 2016, the company reported net income of $17 million compared to net income of $14.1 million for the same period last year. On an adjusted basis, net income would have been $17.3 million for the third quarter of fiscal 2016 compared to net income of $14.4 million for the same period last year, a growth rate of 19.7%. Diluted earnings per share was $0.73 per share for the third quarter fiscal 2016 compared to $0.60 per share for the same period last year. On an adjusted basis, diluted earnings per share for the third quarter of fiscal 2016 was $0.73 per share compared to diluted EPS of $0.62 per share for the same period last year, that's a 17.7% growth rate. Turning to cash flow. The company generated $21.5 million in cash from operating activities in the third quarter fiscal 2016 compared to $17.7 million for the same period last year. Capital expenditures were $4.8 million in the third quarter fiscal 2016 compared to $4.4 million for the same period last year. In the third quarter fiscal 2016, the company paid down $17.5 million of debt and repurchased $2.8 million of company stock. For the 9-month period, the company paid down $42.9 million of debt and repurchased $10.5 million of company stock. The company ended the third quarter fiscal 2016 with $44.4 million of cash on the balance sheet. I'd now like to turn call back to the operator to begin the Q&A session.

[Operator Instructions] Our first question comes from the line of Steve Barger with KeyBanc Capital Markets.

It's Ken Newman on for Steve. A quick question for you. We heard from another bearings company this morning that basically every industrial end market is expected to be flat to down in calendar '16. Would you agree with that? And do you expect that next 2 quarters to be much weaker than the following 2?

We only see the weakness in oil, gas and mining. The other sectors are flat to up a little bit.

Got it. And it was kind of interesting to hear you talk about the demand for aerospace. Could you give a little bit of color about how you're holding on to aero despite what may was choppy aftermarket activity in the last quarter, but saw some significant increase this quarter? And did you see any content wins out of that aerospace segment this quarter?

Well, I mean, yes, the content wins on the OEM side, it's -- these are products that we've been working on for years because it just takes that long after the cycle to design a new ship. So for the A320neo and the 737 Max and the A350 and the 787, we had lots of new content on those ships, and we are sort of in the right place at the right time with our engineers for the past number of years. So we're very -- as those ships -- as those numbers -- production numbers come up on those ships, it's going to be very good for us.

Got it. And then I guess just a follow on, could you maybe address aftermarket activity that you saw in this quarter versus the last quarter?

Yes. Sequential quarters, I'll let Dan -- he's got all the numbers in front of him on that sheet, so I'll let him handle that question.

Yes, on sequential for total aerospace aftermarket were up 3.1% quarter-over-quarter.

And any color as to what's driving -- I know the market's been choppy in that part of the business. Is that driven by anything in particular? Or is that just a continuation of trends?

I think there's been a lot of management changes in that sector. And so I think the new management in several of those companies is now settled in, has some time in grade and has decided exactly how they -- what they want to do to run the company and are back placing their orders again, which we saw a little void there as those management changes were taking place.

[Operator Instructions] We have a follow-up question from the line of Steve Barger with KeyBanc Capital Markets.

Just a couple of more follow-ups here. We're expecting some details out of defense budget likely to be announced next week. Can you talk a little bit about programs that both legacy RBC has been on as well as Sargent that play -- may or may not play a big role for out year revenues if we can start to think about those programs coming to fruition?

Yes, I don't have any prepared notes in front of me. So I'm sort of speaking from memory here, but certainly, we have our eye on the Ohio Replacement Submarine, important system for us. We have our eye on the Joint Strike Fighter, another important system for us. We'd like to see the Apache helicopters. The repair and the building rate of Apache helicopter step up, and I think that's probably inevitable. And the same thing with the -- with some of the Boeing helicopters and the same thing with the Black Hawks. So those sort of are -- some of our key air programs and our marine programs. And certainly, the -- on the ground defense side, we're looking at what's happening there with future planning for the MRAPs and the Bradleys and the Strikers.

Got it. And I guess kind of going back to the helicopter side, I think last quarter, you said -- you mentioned some lumpiness and the timing of some deliveries. Has that kind of carried over to this quarter? Or is that still kind of in limbo in terms of just waiting and the timing of deliveries for that type of -- for that program?

Yes, I don't exactly recall what we said in the last conference on helicopters. I would say that the marine -- the military helicopter market as well as the commercial helicopter market is sort of at a low ebb right now. I mean, it's still a strong performer on our portfolio, but it's down slightly from what it is with a normalized period. So I think right now, we're suffering through the Bill Clinton years. This is sort of a déjà vu of the Bill Clinton administration. And so there's a lot of money that has to be spent on readiness for these systems, and I think it's an inevitable that money is going to be spent.

Our next question comes from the line of Larry Pfeffer with Avondale Partners.

So just trying to walk through both segments looking out here across calendar '16. I appreciate the help there on going to the build rates with Boeing. Looking at the growth rates for the aerospace segment across the year, would you kind of expect it to be kind of low single digits in the first half, ramping up into mid- to high single in the back half?

I think that's a fair characterization. Yes, it might be a little bit stronger in the first half, but let's go with the low single digit.

And then on the industrial side, now that you have oil and mining down to 4%, are you thinking kind of low single digit to flattish kind of bumping up a little bit sequentially across the year?

Yes, I think it's flattish, but we're not expecting any resurgence there certainly on the mining side. And oil, we expect oil will come back like a stampeding stallion. When it comes, it's going to come hard. I think the industry is expecting that.

Got you. And then as you see transition from the legacy 737 to the MAX, any impact on your guys' mix on the gross margin side as that switches over?

No, it's -- we just -- we pick up considerable amount of volume on that side because of the new design of the MAX and the fact that it's going to be using a LEAP engine and we have a lot of applications in the LEAP engine. So that's really good for us.

This concludes our question-and-answer session for today. I would now like to turn the call back to Dr. Hartnett for closing remarks.

Okay. Well, in closing, I'd like to thank everyone for their interest and support and in participating in today's discussions, and we look forward to speaking to you again late spring. Good day.

Ladies and gentlemen, this does conclude today's program, and you may all disconnect. Everybody, have a wonderful day.