RBC Bearings Incorporated (RBC) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the RBC Bearings Fiscal 2016 Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call maybe recorded. I would now like to turn the conference over to Mike Cummings with Alpha IR Group. You may begin.

Good morning. And thank you for joining us for RBC Bearings' fiscal 2016 fourth 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 will turn the call over to Dr. Hartnett.

Thank you, Mike, and good morning and welcome. Net sales for the fourth quarter of fiscal 2016 were $162.3 million versus $113.4 million for the same period last year, a 43.1% increase. Our aerospace markets increased 70% on a year-over-year basis and our industrial markets increased 9.4%. For fourth quarter fiscal 2016, sales of industrial products represented 34% of our net sales with aerospace products at 66%. Gross margin for the fourth quarter was $60.4 million or 37.2% of net sales compared to $44.9 million or 39.6% for the same period last year. On a year-to-date basis, adjusted gross margin as a percentage of net sales was 37.8% compared to 39% for the same period last year. The reduction is principally the result of adding the Sargent businesses to the consolidation. Adjusted EBITDA for the year was $154.9 million versus $119.8 million last year, a 29% improvement. Adjusted EPS for the quarter was $0.86 per share, and for the full year, $3.14, a 14.6% improvement. We continue to implement RBC's manufacturing philosophy and methods into the Sargent facilities and are seeing improvement in margin performance that will continue indefinitely. As I discussed in our last call, the four sources of improvement are; number one, insourcing, that means converting some of Sargent's direct material purchases to RBC plants as the sources as well as we are well along in this project now and expect to see quantifiable impact in fiscal 2017. The improvement of planning and manufacturing methods at the Sargent plants was point number two. Mixed management through pricing as well as focusing our technical resources on what we can do or should do well that is reported with considerable market scale. And of course, continued improvement of RBC core gross margins resulting from maturing and/or new cost reduction projects. Our markets for industrial products saw an expansion of 9.4% for the fourth quarter. Demand continued to be mixed, strong for marine products, which added 15.7%, steady and up slightly for general industrial products. The weak industrial markets continued to be mining, which seemed to have formed a base in oil and gas and semiconductor manufacturer. We saw strength in ground military, train, Europe, U.S., and Asia, machine tools, home construction, and industrial gas turbines. Semiconductor machinery showed considerable strengthening late in the quarter, and we expect a lift from this section this year. Relative to our aerospace business, sales were up 70% on a year-over-year basis for the fourth quarter. Aerospace OEM was up 88.1% and aerospace distribution and aftermarket increased 3.7%. We remain tremendously busy in the quoting, proposal, and contract negotiation phases today as the major worldwide aircraft producers redefine their supply base for the next five years. Of course, we are doing all we can to play a larger role in that supply network and are very optimistic about our future content in this regard. The Sargent acquisition has opened some important new aero industry doors in terms of new products for old customers that are complementary to the classic RBC offering. And just to speak a little bit of our first quarter of fiscal 2017, we are expecting to see sales in the first quarter of fiscal 2017 in the neighborhood of $151 million to $153 million compared to $142.3 million last year. I'll now turn the call over to Dan, who'll provide more details.

Okay. Thanks Mike. SG&A for the fourth quarter of fiscal 2016 was $26.2 million compared to $19.1 million for the same period last year. As a percentage of net sales, SG&A was 16.1% for the fourth quarter of fiscal 2016 compared to 16.9% for the same period last year. Excluding the impact of the Sargent acquisition of $5.1 million, SG&A year-over-year increased $2 million, which was mainly due to $0.9 million in stock compensation expense, $0.9 million in personnel related fees, and $0.2 million in other expenses. Other operating expenses for the fourth quarter of fiscal 2016 was expense of $3.3 million compared to expense of $0.5 million for the same period last year. For the fourth quarter of fiscal 2016, other operating expenses were comprised of $2.4 million in amortization of intangibles, $1.7 million in the litigation reserve offset by $0.8 million of other income. Operating income was $30.8 million for the fourth quarter of fiscal 2016 compared to operating income of $25.3 million for the same period in fiscal 2015. On an adjusted basis, operating income would have been $32.5 million for the fourth quarter of fiscal 2016 compared to $25.4 million for the same period last year. Adjusted operating income as a percentage of net sales would have been 20% for the fourth quarter of fiscal 2016 compared to 22.4% for the same period last year. For the fourth quarter of fiscal 2016, the company reported net income of $18.9 million compared to net income of $14.9 million for the same period last year. On an adjusted basis, net income would have been $20.2 million for the fourth quarter of fiscal 2016 compared to net income of $17.1 million for the same period last year, a growth rate of 18.7%. Diluted earnings per share was $0.81 per share for the fourth quarter of fiscal 2016 compared to $0.64 per share for the same period last year. On an adjusted basis, diluted earnings per share for the fourth quarter of fiscal 2016 would have been $0.86 per share compared to a diluted adjusted EPS of $0.73 per share for the same period last year, a growth rate of 17.8%. Turning to cash flow, the company generated $21.6 million in cash from operating activities in the fourth quarter of fiscal 2016 compared to $9.4 million for the same period last year. Capital expenditures were $6.2 million in the fourth quarter of fiscal 2016 compared to $5 million for the same period last year. In the fourth quarter of fiscal 2016, the company paid down $21.9 million of debt. For fiscal year 2016, the company paid down $65 million of debt and repurchased $10.5 million of company's stock. The company ended the fourth quarter of fiscal 2016 with $39.2 million of cash on the balance sheet. We'd now like to turn the call back over to the operator to begin the Q&A session.

[Operator Instructions] Our first question comes from the line of Steve Barger of KeyBanc Capital Markets. Your line is now open.

Hey, good morning. It's Ken Newman on for Steve.

Good morning, Ken.

Good morning. You may have already said this in your opening comments, but I may have missed it. But can you split out how much Sargent contributed to sales for both industrial and aerospace in the quarter?

For the quarter, Sargent was - total aerospace was $491,756 and industrial was $7,000,946.

That's helpful. Thank you. You gave a little bit of color on strength in industrial sales that you saw and you mentioned marine products as well as just mix demand there. As we look into fiscal 2017, do you have any color or any kind of opinion as to where you see the most strength for industrial end markets going forward?

Well, I can look at the past and I think that's a pretty good proxy for what's going to happen for the next 12 months. Certainly, on the mining side of our business, I think we formed a good base there, and I think we're probably going to run at the levels that we ran in the fourth quarter while next year that sector is supplying their aftermarket. Our industrial business, ex-mining and oil and gas, was actually up sort of worldwide and we expect that industrial business to be a good performer next year. Europe led the way as a matter of fact with about an 18% year-over-year improvement in revenues, so we see some pretty good things happening in some sectors in the industrial businesses, and so I think it forms a very nice base for us.

Great. And then, can you give us - switching over to aero, could you give us an update on aero build rate visibility you have? You mentioned some platform wins or any contracts that are in the pipeline currently. And, I guess, as a follow-up to that any - your take on inventory levels at the OEs you serve and how do you see that changing over the next year?

How much time you’ve got? So long answer. Yes, we know what platforms we're on. We know our content by platform, it's very considerable for some of these platforms for both aerospace and defense. We're very secured with where we are, contract wise and offering wise, and sort of happy about the outlook for the next five-plus years. So if the industry continues to build according to their projections, it's a great story. On the defense side, there's considerable things going on in the defense area that are sort of favorable to us; number one, it's been - the spares on the defense side have been depressed a little bit over the past few years. We're seeing a nice pick up in some sectors for that. We see the Joint Strike Fighter coming onboard in significant numbers over the next three years or four years where we have considerable content on that ship. And we see some - in Europe, we see a lot of ground military activity taking place with new builds of equipment as a result of Ukraine and Paris and Brussels, and it appears that the people there are taking their defense budgets more seriously and are starting to fund some considerable builds of equipment. So I don't know if I answered your question completely, but there is - that's a very long and a complex answer, for sure.

Yeah. No, that's very, very helpful. I do have one more question, I'll jump back in line here. In terms of the margins, you did say that insourcing initiative should convert or you should see - expect some quantifiable results this upcoming year. Can you give us any kind of color on margin expansion here in the first quarter of 2017? Or I guess put another way, how high could incremental margins go in 2017? Do you think you could match 2016 levels or do better?

Well, the timing is a big issue on how quickly we can absorb some of this work and how quickly we can absorb it given the demands of some of the other pieces of our business. But I think our overall goal for the year is to expand that consolidated margin another percentage point. And that's not going to be linear quarter-to-quarter, because as these programs phase in, they have a compounding effect. But I think over the course of the year, our goal is to increase it by 1%, and over a longer cycle, we're trying to bring the whole company into the 40%.

And Ken, just keep in mind, Q1 last year, we only had two months of Sargent in it, this year we'll have three months. So it does have a little impact on gross margin percent.

Understood. Thanks for the time today.

Yeah.

Thank you. Our next question comes from the line of Kristine Liwag of Bank of America Merrill Lynch. Your line is now open.

Hi. Good morning, guys.

Good morning.

Good morning, Kristine.

So, Mike and Dan, just kind of putting together some of the comments you made, if mining and oil and gas is bottoming and - or it bottomed this quarter and you're seeing some pick up in other end markets like marine, semiconductors and ground military vehicles, just to name a few. Should we think about overall industrial sales for fiscal year 2017 to be up mid to high-single-digit and if not, are there other headwinds that we should factor in?

I think our - just to reiterate, I think the mining business has formed a base and that base is aftermarket. There's nothing new being built. So I think we're kind of steady state feeding parts into the aftermarket. And so we have a strategy to grow our business in the aftermarket, which seems to have some legs right now. I think oil and gas really - it can't really affect our revenues any further clearly. That business is about as low as it can go in this period - in this current quarter. So the rest of the industrial business seems to be doing quite well and I would say, if you wanted to put a growth number on there, our objective has always been two times GDP to grow that industrial business and I think that's still a realistic number this year.

Great. And then, you mentioned specifically in the aerospace contract negotiations, I was wondering, are these negotiations business as usual as contracts expire or was there a specific event driver that was out of the ordinary that would make you highlight those five-year negotiations?

Well, I can't say that business with the aircraft builders is business as usual anymore. Given Boeing with their basing strategy and Airbus is trying to come up with something and it's egregious. So these are challenging events normally to negotiate, but where there is risk, there is also opportunity. So we have an opportunity to substantially increase our offering and our mix as a result of what's going on here and we're taking advantage of that opportunity every way we can.

Thanks. And if I could do one last one. On Sargent, I think in the past you've mentioned that there are a couple of businesses that were underperforming and there were a few of that, I think, there was one that near zero gross margin businesses in Miami and Canada and there's also the undermanaged facility in Torrance. I was wondering, if you could provide an update about those business lines and if they're doing better and are they tracking towards more of the RBC Bearings corporate run rate for margins?

Yes. Well, Torrance, because of its scale obviously was high on the priority list in terms of understanding what to do and how to do it and creating an executable strategy that could be achieved in a short time cycle. And we're a long way down the road with Torrance and both in improving their planning, improving their plant execution, improving the technical quality of their staff and improving the access to world class purchase materials and also improving their sourcing alternatives into some of the RBC businesses. So Torrance is going to do very well and it was our first early initiative. Miami is doing extraordinarily well and we're very pleased with the progress we're seeing out of Miami and both on the revenue side and the gross margin side and it's improving on a scale much quicker than we thought it would be. So that's certainly upside to our plan. In Canada, it's running third, sort of the resources have been consumed by some of the other plants. And in Canada, it is one of our focal points for improvement.

Thank you very much. That was great color.

Yeah.

Thank you. [Operator Instructions] Our next question comes from the line of Walter Liptak of Seaport Global. Your line is now open.

Hi, thanks. Good morning, everyone.

Good morning, Walt.

Good morning, Walter.

I wanted to ask a follow-on in the industrial part of the business and wondered about the comps in the fourth quarter and if they're getting easier now in April and May. And so, I guess, I'm asking about your comments with regard to oil and gas. It looks like if you back out Sargent, you had double-digit industrial declines. Are you seeing those declines now more stable and growing in April and May, as we're getting into easier comps? Is there something else going on like you're getting industrial distribution to recover?

Walter, as usual, you're deep into the numbers. Let me explain to you how we see it. Overall, the classic industrial business, net of FX effect, was down 5.6%. So it's down roughly $3 million on $50 million. The oil and gas and mining part of that business is down $5 million on $50 million. And so the rest of it up $2 million on $50 million, 4%. Europe in that equation is, as I said, is leading the way, they're up 18% and that's principally driven by train and tram and renewed interest in ground defense.

Okay. That sounds great. Thanks for that color. Thinking about the industrial distribution, how are trends in North America? You are up to, I guess, through March, are you seeing any improvement as you get further into your 2017?

2017 is very early, I mean, we're just...

Yeah.

Into May right now, so only just month and a half...

But I think we're all hoping for some recovery in industrial and I think industrial distribution is where you would see that first.

Yeah. I would say that if you look at calendar 2017, it's kind of - net of the oil and gas and mining impact. It's kind of flat to up a few percent. It's not burning the barn down.

Okay.

But it's very stable. I mean, it's a very stable source of revenues.

Okay. Sounds good. Yeah, thanks for the comments on the 100 basis points of gross margin improvement in 2017. That sounds really excellent. I wondered if you could comment, is that coming equally from classic RBC or are you expecting more benefit from implementing your process at Sargent?

Well, it's both. 1% is sort of our goal. Obviously, internally, we're pushing all the buttons we can push, both in the classic RBC and at the Sargent. I'd say in the Sargent business, there may be a little bit more room for upside and for every $1 million of outsourced work that we can in source, the contribution margin is probably 40%, 50%. So it's an enormous impact.

Okay. Okay. Great. And if I could ask one for Dan on the cash flow. I wonder what you're thinking about for 2017 free cash flow and debt pay down.

Yeah. We'll be on the same kind of trajectory we are now, but you know we don't give guidance for that. But I think from where we thought we have been at the end of this year, if you add back the one-time charges we - the cash that went out the door for the bank facility and for the acquisition, we'll be right on that $100 million mark that we had for the 12-month period going into the first quarter. So I think we're happy with the cash generation. We made some strategic investments in the Sargent and working capital. Our CapEx is under control it was very good levels in 2016 and we don't expect major impacts in 2017 from that. So I think we'll have some nice upside to what we owe to achieve this year.

Okay. Great. At what point do you feel that you've got the bandwidth to do acquisitions again? Are you actively looking for M&A at this point?

No, we'll continue to look. Right now, obviously there is - we've got a lot of housekeeping to do with the businesses that we have. We continue to work that. But we have - we continue to read the books that are sent to us by nice folks like yourselves and we continue to bid on businesses that are sort of strategic and synergistic with us that are - I would say they're more on the bolt-on category right now, is what we're seeing. But we need some technical augmentation of our existing skill set to do some things in the markets that we think are going to be very valuable to the company. So that we're looking at certain companies that are sort of in the $15 million to $30 million range that have those technical skill sets that can be applied to some of RBC's markets. So that's where our focal point is right now. If we saw an acquisition that had the characteristics of Sargent and those characteristics would be something like synergistic to our markets, products that we know how to make, the manufacturing processes that we're very comfortable with, undermanaged businesses that can show considerable margin improvement and well-regarded product lines; we probably would be tempted, but at this point, we haven't been tempted.

Okay. All right. That sounds great. You did a great job with Sargent and so I think we all look forward to the next one.

Thank you, Walt.

Thank you. Our next question comes from the line of Joseph Ciarleglio of Bradley, Foster. Your line is now open.

Hi, Mike and Dan.

Good morning.

Just a quick question. So a recurring theme at - from a lot of the presentations at last week's Electrical Products Group Conference was that there's little to no economic growth globally and we're operating in an onerous regulatory environment that political climate, et cetera, customers are scared to invest. Just wanted to ask for your thoughts on the overall operating environment and how you guys things?

To start with aerospace, I mean, right now, it's the great aerospace build rate race, right? And so there's lots of investment going into that sector, there's no question about it, sort of nationwide, worldwide and we're optimistic and participated in. Some of the industrial sectors are soft. I mean, we're not big into ag, but we'll see what's happening there. It doesn't seem to be much of an opportunity to participate in any upside in the ag business. But housing, very strong; auto, reasonably strong to record strong depending upon region of the world and aerospace is still very, very good. So I think you have to - and semicon now is starting to have back up, I mean look at Applied Materials stock and read their analyst coverage and you can see what's driving that. And so there is places in the world that are doing extremely well. Fortunately, in the bearing business, everything that moves needs a bearing, that's how it moves. It moves through a joint with a bearing, might be a simple little thing, might be the most complex thing in the whole world, but it needs a bearing in their joint. And so, fortunately, in the bearing business, you can sort of decide what industries you want to participate in based upon the future of those industries and develop a game plan and a strategy to enter. We try to stay close to our existing markets to the most - to the greatest extent, because we got people that understand that customer base in those markets and how those machines move and what they need for bearings. But if we saw an interesting market developing that had the financial characteristics that were attractive to us, we would definitely retool our infrastructure and our engineering and marketing staffs to get into that business and we do that all the time and right now, we're doing it with train.

Great. I appreciate the color.

Thank you. And I'm showing no further questions at this time. I'd like to hand the call back over to Dr. Hartnett for any closing remarks.

Okay. Well, I thank everyone for participating in today's call and asking the good questions that you ask and you know the - we'll be issuing the proxy pretty soon. So we'd like to have you all vote in favor of management's recommendation. Thank you and we'll talk again in August.

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Have a great day, everyone.