Good day, ladies and gentlemen, and welcome to the Third Quarter 2018 RBC Bearings 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. As a reminder, this call is being recorded. I would now like to turn the call over to Chris Donovan with Alpha IR. You may begin.

Good morning. And thank you for joining us for RBC Bearings fiscal 2018 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, Chief Financial Officer and Chief Operating 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, Chris, and good morning. And welcome to RBC's conference call. Net sales for the third quarter fiscal 2018 were $166.9 million versus $146.7 million for the same period last year, a 13.8% increase. For the third fiscal quarter of 2018, the sales of industrial products represented 37% of our net sales, with aerospace products at 63%. Gross margin for the third quarter fiscal 2018 was $64.7 million or 38.8% of net sales. This compared to $52.4 million or 35.7% for the same period last year, a 23.4% increase. Adjusted operating income was $33.1 million versus $20.5 million last year, a 61.3% increase. Clearly, this was a very positive and exciting quarter for the company. The startup expenses on new programs referred to in the last call are now producing the benefits of better margin performance for their relative product lines. There are more startups ahead as we begin to tool for new plane and engine component awards. Adjusted diluted EPS for the quarter was $1.05. Free cash flow for the quarter was $20.6 million; and correspondingly that was reduced by another $22.6 million. EBITDA came in at $44.4 million, 26.6% of revenues. Industrial products showed a 23.1% year-over-year growth rate, and we continue to see strong overall demand for these programs. Industrial OEM was up 23.2%, and distribution and aftermarket was up 22.8% on a year-over-year basis. Mining, oil and gas, semiconductor machinery, machine tool and general industrial equipment demonstrated exceptional strength during this period. On the aerospace and defense side, this quarter, the sector showed a 8.9% expansion. Aftermarket revenues, often lumpy, were flat for the period. Aero OEM was up 9.8%, while defense jumped 23.4%. As you may know, the step-up in build rates for the single-aisle planes this year 2018 is planned to add another 160 planes. And there will be an additional 160 planes that are planned for calendar year 2019. That's assuming everybody can get all the parts, particularly engines. In terms of RBC revenue, this adds about $20 million additional per year approximately. This volume will impact an already very taxed infrastructure industry-wide. We are adding capacity and, in some cases, expanding facilities in the United States, Mexico and Europe accordingly and in-sourcing processes to accommodate this demand where external support is insufficient. This is ongoing, and I'm sure there'll be more discussion of this in the Q&A period. Regarding our fourth quarter, we are expecting sales over the period to be between $172 million and $175 million, compared to $160 million last year; an increase of 7% to 9%. Of course, this is without any contribution from our Canadian plant, which ceased production in December, which would have nominally contributed $3 million to $3.5 million to the revenue line, bringing the overall expansion probably closer to the 10% to 11% range. I'll now turn the call over to Dan for more detail on the financial performance.

Thanks, Mike. SG&A for the third quarter of fiscal 2018 was $28.2 million, compared to $25.7 million for the same period last year. The increase was mainly due to higher personnel costs, $1.7 million; $0.3 million of additional incentive stock compensation; and $0.5 million of other items. As a percentage of net sales, SG&A was 16.9% for the third quarter of fiscal 2018, compared to 17.5% for the same period last year. Other operating expense for the third quarter of fiscal 2018 was expense of $3.4 million, compared to expense of $6.1 million for the same period last year. For the third quarter of fiscal 2018, other operating expenses were comprised mainly of $1.1 million related to restructuring of our Canadian operation, $2.3 million in the amortization of intangibles. Other operating expense for the same period last year consisted mainly of $3.8 million in restructuring and integration costs associated with our industrial manufacturing operations in South Carolina and $2.3 million in the amortization of intangible assets. Operating income was $33.1 million for the third quarter of fiscal 2018, compared to operating income of $20.5 million for the same period in fiscal 2017. On an adjusted basis, operating income would have been $34.2 million for the third quarter of fiscal 2018 compared to $27.6 million for the same period last year. Adjusted operating income as a percentage of net sales would have been 20.5% for the third quarter of fiscal 2018 compared to 18.8% for the same period last year. For the third quarter of fiscal 2018, the company reported net income of $23.8 million compared to net income of $12.8 million for the same period last year. On an adjusted basis, net income would have been $25.7 million for the third quarter of fiscal 2018 compared to net income of…

Our first question comes from Kristine Liwag of Bank of America. Your line is open.

Hey, guys. Good morning.

Good morning, Kristine.

Mike, you mentioned in your prepared remarks that there is bottleneck in the engine side of the commercial aerospace supply chain. I was wondering, with the OEMs having already announced production rate builds through 2019, what kind of shortage would we have to see for these rate increases not to go as planned, aside from a few months of delay that we're seeing today?

Well, I don't want to speak specifically to engines, Kristine. I know of the engine situation just because I read the industry literature. But the situation for services for RBC is straining. It is – it's definitely having an effect on our revenues. We have – there are lots of processes that we have to go outside to approve suppliers to complete the process to make our product. And it's clear in many cases that these approved suppliers don't have the industry capacity to support the demand on a timely basis. And I'm probably talking more airframe than engine-related issues. I kind of understand the engine-related issues, but I'm really focused more on the airframe side of the business. And that is definitely having some effect on our Q4 outlook.

I see. And you've mentioned in-sourcing as a tool that you're doing in order to make sure you have enough capacity. How much money do you have to spend to get to be prepared for this rate increase? And then also the $20 million in incremental annual revenue that you mentioned, what's your implied gross margins on that business?

Kristine, you want to know everything. I think first question, yes, it's our typical airframe mix. So it's good margin business for us. It's kind of representative of what we produce now and maybe a little bit better because we've gone sort of a long way into improving our processes and our automation techniques and et cetera. And so, we're always working to expand the margins. And particularly on our stable mix, that's a big focus for us. So margins are very good. And what do we have to do in order to expand our capacity here, well, we are currently in-sourcing – working on programs to in-source and get approvals for plating; and we've gotten some of those approvals already and we're organizing more internal plating capacity. We are working on in-sourcing some of our heat treating capacity. Heat treating is a definitely an industry bottleneck. We have in-sourced a lot of our HVOF capacity, which is the High Velocity Oxygen Fuel technique used to coat, put basically ceramic coatings on components for airframe to prevent their corrosion. And so, that's been a bottleneck for us. We've recently received approvals from Boeing, and we expect to receive approvals from the engine makers later in the year to in-source a lot of those requirements. So those are very active areas for us that we're working on right now. And there is no question we're being pinched here and there in various divisions on throughput based upon the ability of the industry to support us.

So just to understand, are these in-sourcing initiatives, would these eventually increase your margins in the long run? Or are these things that you have to in-source so that you can meet the rate increases?

Well, let's put it this way. Currently, we buy them on the outside, and the guy that makes it for us on the outside doesn't supply it to us at his cost. So he makes a margin depending upon the processes that he's supplying, and some of these margins from processing companies can be very substantial. So we would expect to see a margin improvement, as well as a capacity increase.

Great. Thank you very much, guys.

Yes.

Our next question comes from Pete Skibitski of Drexel Hamilton. Your line is open.

Good morning, guys. Nice quarter.

Thank you, Pete.

Mike, let me start with the lower effective tax rate. You've got a pretty nice cut in your effective tax rate, so you could generate a lot more cash. Are you expecting any changes to your capital deployment strategy going forward as a result of that? And maybe just to get maybe a little more clarity on the CapEx outlook, from an absolute basis, will that kind of stay flat from an absolute basis now or any other directional difference?

Pete, it's not going to change a lot, but it's going to change some. And it's hard to predict exactly the flow because these are all project-driven. So to incorporate a lot of these processes, in some cases, we're quite far down the road and have approvals and have incorporated the process. In some cases, we're just breaking ground for new facilities to incorporate the process. So it's kind of a mixed. We'll definitely spend our historical cap rate – CapEx rate. And there'll probably be a bulge there of 25% depending upon what year this all happens. But there is – there's no question that we need to add both capacity and augment some of our facilities.

Okay. Okay. So that sounds like the predominant use of your incremental free cash from the lower tax rate. You'll get a bit of a CapEx bulge, as you described it for a year or two.

That's right.

Okay. Okay. How about – can you give us an update on the M&A environment?

Yes. I mean, we're getting to the point in terms of leverage ratio where we're paying down a lot of debt and we can see the day when it's all paid down. So these acquisitions come in various sizes. And we have line of sight on some nice small acquisitions today that are very – very complementary to our business model and our product structure. So we like those that they should give us a little bit of a leg up on our position in the market. We continue to look for acquisitions the size of Sargent. They're the right fit and the right quality. And we don't have the line of sight on one of those today. But we continue to work on it. And we sooner or later the right one will show up.

Sounds great. Sounds great. I do want to ask also the Vanguard program from last quarter. Is that impact over now or is that all a lingering project?

Yes, that's kind of settled down. It's – I don't know if it will ever be over, but it's staffed properly and functioning accordingly.

Got it. Okay. While I'm on, I'm guessing there are too many more analysts. But on the industrial side, just the super-growth year-to-date in the industrial sector for you guys, I wonder if you can give me a sense of how much longer the easy comps in industrial should last, if you're anywhere close to what peak revenue was in industrial. And then if it just feels like the economy is really starting to pick up for you or not?

Well, the demand in Q3 was real – stronger than we expected. Okay? And customers, in many cases, wanted shipments from us earlier. A product that was planned in the fourth quarter, they wanted in the third quarter. I see that very seldomly year-to-year. I mean, maybe that happens once every five years or six years in this business. It happens so infrequently, I forget the last time it happened where they're pulling product into our third quarter, which is normally their fourth quarter, and they're trying to hit metrics about inventory turns and all that stuff that they're judged on. And so they're usually delaying that situation. So, the question is, is that going to happen in our fourth quarter? So we – in terms of our fourth quarter outlook, what we did is we have – we don't have good algorithms to predict that accelerated demand. We have – our algorithms predict sort of normal demand. So for our fourth quarter, what we did was we took our backlog in our normal algorithm and we just laid it in place accordingly. So if people start accelerating requirements into our fourth quarter, you know, god bless them. I mean, our inventory positions are sort of in a A-minus category right now in terms of fulfillment. So we'd be able to support it, but we definitely didn't cook it into our numbers.

Okay, okay. And then, I remember last year I think your industrial business, I believe, was still down like 40% organically from the prior peak.

Right.

Are you still down quite a bit year-to-date from the prior peak?

That's something I'd have to go back and measure. I think we're getting up there.

Got it. Okay. Fair enough. Last one from me. Year-to-date, if we look at the actual reporting segments, I guess, roller bearings as well as ball bearings have had outstanding year-to-date revenue growth, pretty strong double digits. Can you add any color as to the particular drivers in those two segments, the roller bearings and the ball bearings segments?

Yes. In the ball bearings segment, it's mainly driven by semiconductor and general industrial product offering. And the roller, it's mainly driven by general Industrial and oil and gas.

Okay. Okay, great. Very helpful. Thank you, guys.

Yes.

Our next question comes from George Godfrey of CL King. Your line is open.

Good morning, and thank you for taking my questions. Nice quarter.

Hey, George.

Hi there, Dan. Just want to be clear on the CapEx. So 25% increase, probably like a $5 million number on the CapEx to support the expansion. Is that right?

Yes, it's probably a little on the high side, but it's...

Okay.

...a safe number.

And then, as you ramp up the production on these newer parts for the newer platforms, I understand the margins will definitely come in higher than legacy programs eventually. But you are expecting higher margins as the initial ramp takes place or will they come in at a lower margin because you haven't been able to move down the cost curve?

Well, they never come in at a high margin. I'll tell you that. I mean, manufacturing is all about hitting the maturity curve in making the stuff.

Okay, okay...

Normally, the startup on these programs can be difficult and sometimes surprising in terms of what you have to do to make it versus what you expected you'd have to do to make it. So it's a matter of working through all the variances, getting the capital equipment in place, getting it tuned, getting the wheels and the cutters to produce at the right rate and to have a life cycle that's affordable. And so, it's fine-tuning. And basically we're very good at that, we're very good at that. And we have some programs, which are very large, that are sort of write-down, right, starting to hit their sweet spot in the maturity curve right now and we're very pleased with it. And we have other programs that we're right at the beginning of the start-up for initial lab production rates, and they're challenging.

Got it. Can you tell me what the head count was at the end of Q3?

George, I don't have that with me, but I'll give you a ring today and follow-up with you on the head count number.

Great. Thank you very much for the color.

Our next question comes from Steve Barger of KeyBanc Capital Markets. Your line is open.

Hey, good morning, guys.

Hey, good morning, Steve.

On the industrial side for the 23% growth, can you tell us how much of that was price versus volume?

There wasn't much price.

So mostly volume.

It's mostly volume.

Yes. If customers are wanting product earlier than previously forecasted, does that give you room for price increases as you go into fiscal 2019?

It's more the exception in the rule, particularly on the industrial side.

The exception that you'd be able to raise prices?

Well, if the customer wants it sooner and he ordered it in the fourth quarter and it's under contract or it's under a price sheet and you have it in your inventory; it's pretty much sold at the price that you agreed to sell them. On the other hand, if he came in, he ordered it late, you have to do extraordinary things to get materials and rush it through the plant, people have to work on Christmas. Then there's – we're going to charge him an acceleration fee, but that's the exception to the rule.

Got it. For those OEM customers that are wanting product pulled forward, which verticals are you seeing that in? Is this construction equipment or machines for factory production?

Everywhere. All of the above. When the PMI gets between – goes from 55 to 60, I mean, for us that's the Land of Oz.

Right.

I mean, the demand for our products is just – it's outstanding in that zone. And the problem really becomes one of maintaining inventory availability and ultimately producing at a replacement level that doesn't dry out your inventory positions. And very often it goes right into the raw material, getting the raw material soon enough to be able to replenish your inventories. So we've made some substantial strategic buys on a raw material to position it so that we could accelerate our production when we need to.

Are you sensing any weakness or hitches in the supply chain when you go out to do some accelerated buys?

Yes.

Is that just specialty alloys or where is the...?

Yes, it's specialty – it's specialty alloys for sure.

Can you infer...

That's one of the reasons we're doing these accelerated buys.

Right. Just to make sure you have the product on the floor.

Right.

Could you infer anything about having both OE and aftermarket accelerate at similar rates at this point in the cycle? Does that mean anything to you? Is it...

Well, it just seems for the – what we call the aftermarket is really not the replacement market. It's a lot of small – it's replacement plus a lot of small OEMs. And that bias route industrial distribution or aircraft distribution that we wouldn't normally service, we just can't service that many customers. We're not equipped to do it. So I just think it's a very broad-based manufacturing resurgence. And I think when I look at the way that this new tax law has impacted RBC, and I multiply that times 10,000 companies, I think the effect of this new tax law on what's going to happen in calendar 2018 is going to be very impactful. And that assumes that the stock market doesn't scare the hell out of the consumer.

Right. And so I guess just to that point, and as you think about the pipeline for M&A, and you said you had line of sight on small deals. Are those $5 million or $25 million types of deals, and are you seeing any accelerated desire for entrepreneurs to sell?

It's – it's – yes. It's actually in the $5 million to $50 million zone. So we have a few in those categories. And now, I think these are – we're not seeing any great acceleration in entrepreneurs. I mean, we wouldn't see that originally anyways. I mean, it would be an investment banker or a broker or somebody that would bring that to us. And so if that's happening, we don't have knowledge of it.

Got it. Thanks very much for the time.

Okay.

There are no further questions. I'd just turn the call back over to Dr. Hartnett for any closing remarks.

Okay. Well, I thank you again for your interest and all your questions about our business. And it's been our pleasure to talk to you. And we'll speak again later in the year.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone, have a great day.