Earnings Call Transcript - RBC Q1 2020

Operator, Operator

Good morning, everyone, and welcome to the Q1 2020 RBC Bearings Earnings Conference Call. This call is being recorded. I will now hand it over to your host, Mr. Chris Donovan.

Chris Donovan, Host

Good morning, and thank you for joining us for RBC Bearings Fiscal 2020 First 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.

Michael J. Hartnett, CEO

Thank you, and good morning. Net sales for the first quarter of fiscal 2020 were $182.7 million versus $176 million for the same period last year, a 3.8% increase. Organic growth for the quarter was 6.5%, and we think that’s a respectable start for FY2020. For the first fiscal quarter, sales for the industrial products represented 36% of our net sales with aerospace products at 64%. Gross margin for the quarter was $70.7 million or 38.7% of net sales. This compares to $67.7 million or 38.5% for the same period last year, a 4.4% increase. Operating income was $38.5 million versus $36 million last year, a 6.9% increase. EBITDA was $50.8 million, a 7.9% increase over last year. We are very pleased with the performance for this quarter and it follows an excellent year for the company. During the first quarter, industrial products lost some ground over the period, and we’re down about 7.2%. Last year, the expansion in that quarter was 18.3%, so we are up against some pretty difficult comparisons. Industrial OEM was down 7.2% and distribution in the aftermarket was 7.1% down year-over-year. On the aerospace and defense side, the first quarter organic net sales were up 16.3%. This was driven by both OEM and aftermarkets. Aero and defense OEM were up 14.6% on an organic basis. Supply constraints internal and external have been significantly mitigated as a result of our internalizing many processes certified today. More internalization of the processes will follow. This sector will likely continue to perform at double-digit growth levels for the foreseeable quarters as we introduce additional manufacturing capacity and convert new contracts currently in the reach. At this point in our year, we enter our second quarter, most of our aerospace businesses are booked at or beyond fiscal 2020. If the 737 MAX receives its FAA certifications in calendar Q4 and production is accelerated, it may be difficult to support the demand by the subcontracting base. We continue to add capacity to support our customers’ future requirements and should be well positioned for FY2021 in this regard. Regarding our second quarter, we are expecting sales to be between $180 million and $182 million, which results in organic growth rates of 6.5% to 7.7% over last year. If we can produce more, it will have a greater turnout in sales, but it’s largely on the aerospace and defense side as a capacity constraint.

Daniel A. Bergeron, CFO

Thanks, Mike. SG&A for the first quarter of fiscal 2020 was $30.1 million compared to $29.6 million for the same period last year. The increase is mainly due to about $1 million of additional incentive stock compensation and $0.1 million of other items, offset by $0.6 million of lower professional fees. As a percentage of net sales, SG&A was 16.5% for the first quarter of fiscal 2020 compared to 16.8% for the same period last year. Other operating expense for the first quarter of fiscal 2020 was an expense of $2.1 million compared to an expense of $2.2 million for the same period last year. For the first quarter of fiscal 2020, other operating expenses were comprised mainly of $2.3 million in amortization of intangible assets, offset by $0.2 million of other items. Other operating expense for the same period last year consisted mainly of $2.4 million in amortization of intangible assets, offset by $0.2 million of other items. Operating income was $38.5 million for the first quarter of fiscal 2020 compared to operating income of $36 million for the same period last year. Other nonoperating expenses were $0.2 million for the first quarter of fiscal 2020 compared to $1 million for the same period last year. For the first quarter fiscal 2020, other nonoperating expenses were just comprised of $0.4 million of foreign exchange loss, offset by $0.2 million of other items and other nonoperating expenses for the first quarter of fiscal 2019 consisted primarily of a $1 million loss on early extinguishment of debt. For the first quarter of fiscal 2020, the company reported net income of $30.5 million compared to net income of $27.5 million for the same period last year. And on an adjusted basis, net income was also $30.5 million for the first quarter of fiscal 2020 compared to an adjusted net income of $28.1 million for the same period last year. Diluted earnings per share was $1.23 per share for the first quarter of fiscal 2020 compared to $1.12 per share for the same period last year. On an adjusted basis, diluted earnings per share for the first quarter of fiscal 2020 was also $1.23 per share compared to an adjusted diluted EPS of $1.15 per share for the same period last year. Turning to cash flow. The company generated $40.1 million in cash from operating activities in the first quarter of fiscal 2020 compared to $33.8 million for the same period last year. CapEx was $12 million in the first quarter of fiscal 2020 compared to $7 million for the same period last year. In the first quarter of fiscal 2020, the company paid down $17.1 million of debt and ended the quarter with $32.7 million of cash. I’d now like to turn the call back over to the operator for the Q&A session.

Operator, Operator

Your first question comes from the line of Pete Skibitski of Alembic Global. Your line is now open.

Pete Skibitski, Analyst

Can you give us maybe a sense of where you saw the weakness in industrial OEMs? Is it across the board, general economic weakness? And do you sense that things could get worse or maybe by the fourth quarter, things would normalize on a comp perspective? What are your thoughts there?

Daniel A. Bergeron, CFO

Yes. It’s the same four major industries that we discussed in Q4. It’s mining; energy, which is oil and gas for us; semiconductor; and general distribution that were mainly impacted. I think if you look quarter-to-quarter, our industrial OEM Q1 compared to Q4 is actually up 1.8%, so we continue to push hard on the OEM side. Distribution, I think there’s a lot of restocking and inventory deleveraging that the distributors in the industry have gone through over the last four months, and that impacted the business. We’re starting to see long-term orders actually picking up into our Q3 and Q4. For us, it’s where we’re going to count on our in-and-out business within the quarter to see how the quarter comes out. We count on about at least 30% of our revenue on the industrial side from in-and-out activity within the quarter.

Pete Skibitski, Analyst

Got it. Okay. I’ll just ask one more and I’ll get back in the queue. Can you talk about the strong first quarter margin? You guys had talked about a good pricing environment in the past and the margin benefits of insourcing and automation, so is there one thing that you can maybe point to, to pin down what the driver was of the great margin? And I’d love to hear more about kind of trends going forward on that front.

Michael J. Hartnett, CEO

Yes. I think the margin could have been better, Pete. We have several programs that are still in start-up, and these are major programs for us. We continue to see margin expansion all the way through the rest of this year. I just came back from Southern California, spending a week with the operations over there, and I think we’re making really good progress on several of our sites on major programs in terms of execution and getting approvals on key processes that we need to in-source. That’s going to all accrue better margins in the future. So the margins were strong this quarter, and what do they say, you haven’t seen anything yet.

Pete Skibitski, Analyst

That’s great news. So you guys are actually talking about insourcing even more than what you had previously planned and talked about over the last year.

Michael J. Hartnett, CEO

Well, we probably just didn’t talk about it in the detail that may have been needed. But yes, I mean if you look at the kinds of things that we’re insourcing – we’re insourcing cad plate, copper plate, chrome plate, heat treatment, HVOF processing, nickel plate, aluminum pigment coating, powder lubrication, and elastomeric bearings. We’re insourcing all of that stuff, and we’re pretty far along in terms of the industrialization of those processes and the certification with the OEMs to supply from those internal processes. I think we’re about maybe one-third of the way through the process approval with the OEMs, which is sort of the long pole in the tent. But I think that’s accelerating now. The more difficult processes have been approved, and I’d expect by the end of December, we’ll be two-thirds of the way through the approval. We have some new equipment coming in, which can’t be approved until it’s cited, and so that will be cited in our third quarter. Probably those processes approved in our fourth quarter. It’s significant. It’s a big deal.

Pete Skibitski, Analyst

That’s great. Thanks for the color, guys. I appreciate it.

Operator, Operator

And your next question comes from the line of Steve Barger of KeyBanc Capital Markets. Your line is now open.

Steve Barger, Analyst

Hi, good morning, guys.

Michael J. Hartnett, CEO

Good morning, Steve.

Steve Barger, Analyst

I’m going to stick with the industrial question. We’ve seen revenue coming in light, but not so negative year-over-year for some end markets. Are you able to track market share? Or do you think there has been any shift in the served end markets, any aggressive pricing from competitors or new products that are gaining some momentum?

Daniel A. Bergeron, CFO

No. I don’t think we have, Steve. I think it’s just – some of these markets are fairly big for us. And they’re all for oil and gas and mining. Both of them are 10 to 15 plus size markets for us. We had a really nice quarter last year, which puts a little bit of pressure on that comp. Distribution was down. Offsetting some of this was our Marine business and – which is – as we talked about on the Q4 conference call was going to be a light year on growth. It’s still going to have growth because when we’re down to one boat build with Newport News on the Virginia-class subs, but that’s definitely going to jump up in the coming years into 2021.

Steve Barger, Analyst

Okay. And so just from a mix standpoint, as I think about next quarter, would you still expect down revenue industrial and more like a double-digit growth rate for aerospace? Or are you starting to see aerospace moderate more and maybe more of a recovery in industrial? How should I think about that for the quarter coming up?

Daniel A. Bergeron, CFO

I think, once again, the industry had another tough comp, so we’ll be down on the industrial side and we’ll have double-digit growth somewhat like we experienced in Q1 for aerospace and defense.

Steve Barger, Analyst

Got you. Any – you talked about those four big end markets for you. We are seeing some construction orders start to moderate – is that – construction equipment. Is that a big market for you historically? Or what are you seeing there through the channel?

Daniel A. Bergeron, CFO

It’s not a huge market for us. Mining for us would be heavy haul trucks for Caterpillar, Komatsu, Liebherr, folks like that. We’re starting to see that coming back in again, but it’s booking into our Q3 and Q4. Those lead items are a little longer than the normal in-and-out business that we get in the quarter.

Steve Barger, Analyst

Got you. But cranes, aerial work platforms, that sort of thing, not as big?

Daniel A. Bergeron, CFO

No.

Steve Barger, Analyst

Got it. Okay. Back in line. Thanks.

Operator, Operator

And your next question comes from the line of Kristine Liwag of BofA Merrill Lynch. Your line is now open.

Kristine Liwag, Analyst

Good morning, guys.

Michael J. Hartnett, CEO

Good morning, Kristine.

Kristine Liwag, Analyst

On the 737 MAX today, could you discuss the volume that you have and the implied production rate that you’re currently producing? And then also, if Boeing were to go ahead and have a temporary pause in the program, what would that mean for you?

Michael J. Hartnett, CEO

Let’s see. Our current volume – we’re currently feeding the 737 MAX at the 42 ships per month rate. Some operations are a little more, some operations a little less. I don’t know why that occurs that way, but it is what it is. We noticed in some operations that the demand rate is 32, and in other operations, the demand rate is 52. From the information that we’re getting from Boeing, they expect to turn that ship on in October. Now I’m sure they know more than I do, so I have no comment on that. But they’re telling the supply base to get ready to turn that ship on in October at such and such rate. And to bring that rate up substantially quarter after quarter. So let’s hope that’s the case. If there is a pause, I’m not sure how that’s going to affect us because really our schedules are loaded, and we have new contracts that we expect to be signing soon, which will more than offset any of the pushouts that we would expect as a delay. I think our aerospace business is really kind of locked and loaded for the balance of fiscal 2020.

Kristine Liwag, Analyst

That’s helpful. And maybe switching gears. You ended the quarter with a net cash position, and your stock’s pretty close to a record high. So you’ve got currency there if you want to use it as well. Can you discuss the pipeline then for M&A? And what are your strategic and financial requirements?

Michael J. Hartnett, CEO

Well, the pipeline for M&A is good. We continue to look at small and large M&A options. We actually expect to complete something small in our second quarter. Whether that actually occurs or not is anybody’s guess, but it looks pretty positive.

Kristine Liwag, Analyst

What are your hurdles, the strategic hurdles, financial hurdles that you’re looking at either return on invested capital or some sort of metric?

Daniel A. Bergeron, CFO

Well, Kristine, for us, we look to have a business that we can bring in that will have the same synergies and products that we can bring across our current customer base. We’re looking for it to be accretive in the first year and to be able to meet and exceed our current targets on return on invested capital, which is a little north of 12% now. From a leverage standpoint, when we did the Sargent deal, we levered up to a little close to three times. That wouldn’t scare us. We told the Street we’d pay that down in five years, and we paid it down in four. If we could find another Sargent deal, that would be great. In the meantime, we’re also looking at a lot of tuck-in opportunities that are really nice product line extensions to our current business model.

Kristine Liwag, Analyst

Thank you, very helpful.

Operator, Operator

And your next question comes from the line of George Godfrey of CL King. Your line is now open.

George Godfrey, Analyst

Thank you. Good morning. Thank you for taking the question. Two questions. The first one is, just for the sake of argument, if Boeing on the 737 were to lose customers to the Airbus A320, would it be a difficult issue for you to ramp up A320 production for your ship step versus the Boeing 737? Or would that take time to reconfigure factory and volume floors?

Michael J. Hartnett, CEO

Well, we have substantial content on the A320 also, so it would move. That is much content. We probably have 80% of the content on the 320 as we have on the MAX.

George Godfrey, Analyst

From a production standpoint, it wouldn’t be difficult to ramp up that production versus pushing down the 737? That’s what I was trying to get at.

Michael J. Hartnett, CEO

It’s pretty much what we’re tooled on. Many parts that are used on both ships are virtually identical. Many parts are not, but a lot of them are. It wouldn’t be difficult. Obviously, the LEAP engine is the same engine on both ships, and the gear turbo fan is the engine on the 320. We have a substantial presence on both engines.

George Godfrey, Analyst

Got it. And then the second part is, on the capacity constraints, I just wanted to delineate between shop floor space and equipment versus OEM certification. By the end of September, from an infrastructure standpoint, will you have the equipment and shop floor space ready to go, and now you’re just waiting for the OEM to be certified or the process to be certified? Or would that also need more equipment and more space in the December or March quarter next year? Thanks.

Michael J. Hartnett, CEO

Well, on an 80-20 basis, 80% of the equipment is in place. The plants are built. The processes have been installed. Some have been certified already. More than one-third of them have been certified already. We have OEM representatives in here every week working to certify the other sites. I think we’re kind of where we need to be. We have some very substantial contracts that we’re expecting to convert over the next eight weeks, which will push the machinery issue a little bit in some of the plants, and we’ll have to tool some of the plants with more of the same.

George Godfrey, Analyst

Got it. Thank you for taking my questions.

Operator, Operator

Thank you. And next question comes from the line of Michael Ciarmoli of SunTrust. Your line is now open.

Michael Ciarmoli, Analyst

Hey, good morning, guys. Thanks for taking the questions. Just back to the 737. It sounds like even if we get certification, Boeing potentially talking about picking up, it sounds like it’s going to take about two years to burn down the inventory of 737. I mean, does that have any impact on how you guys are looking at sustaining the double-digit growth rate scenario if we see a flattish production rate of 52?

Michael J. Hartnett, CEO

Yes. I mean I don’t see a two-year burn-down rate. I mean, they’ve only been out of shipping for the last three or four months. I mean they’ve got the backlog and just not been shipping.

Michael Ciarmoli, Analyst

Well, that’s what I mean. Spirit Aerosystems is going to have – even into October, they’re going to have close to 100 fuselages. They basically said they’re going to be at 52 all of next year, regardless if Boeing – if they get that plane. The unfinished product is going to be out there. Again, the airline’s ability to take delivery of these planes is going to slow that process as well.

Michael J. Hartnett, CEO

I don’t think this subcontracting base can be put together that fast because some of these guys stayed in production at the 52 rate. Some of them didn’t have the working capital support for the 52 rate. Some of them didn’t believe Boeing that they were going to come back that strong. Everybody had their own opinion on how to run their operation. To put Humpty Dumpty back together again is going to take some time and a lot of glue. If they can get back to the 52 rate next year, they’ll be doing good. Their objective is obviously higher than that. Frankly, if they get back to the 52 rate, we’ve got so much content on some of the other platforms that are new and tooled. I suspect we’re still going to be in that double-digit range.

Michael Ciarmoli, Analyst

Okay. Is that – and you mentioned the content. I mean – because as we look into these coming quarters, there’s quite honestly not that much growth in terms of deliveries. The 787 is at rate, 350 is at rate, 777 looks to be delayed. I mean we just covered 777. A320 might have a little bit. So are you – I mean it sounded like from the last call too, market share gains, content expansion. Is that going to be the supporting driver behind the double-digit growth rate?

Michael J. Hartnett, CEO

Yes. Yes, it’s market share gains and the content expansion. It’s exactly right.

Michael Ciarmoli, Analyst

Got it. And then just last one on the industrial. Can you give us – you talked about the four key OEM markets. Can you just give us a sense from last quarter to this quarter, which one got better sequentially and which ones got worse sequentially?

Daniel A. Bergeron, CFO

No, I can’t. I have last quarter in front of me. I’d have last year Q1. It’s just the ones we talked about, but I’m sorry. I just don’t have the Q4 numbers in front of me.

Michael Ciarmoli, Analyst

Okay. Got it. But everything we do believe that sequentially – the ordering trends. I think you mentioned you’ve got some pretty good line of sight. You haven’t seen any erosion in any of those end markets? I mean semi has been having a pretty trying time, but nothing that really jumps out?

Daniel A. Bergeron, CFO

No. As a matter of fact, we’re starting to see semi starting to point up again, so it won’t impact Q2. We’ll feel more in Q3 and Q4, but it’s more positive.

Michael Ciarmoli, Analyst

Okay, okay. Perfect. Thanks a lot, guys. I will jump back in the queue.

Operator, Operator

Thank you. Your last question comes from the line of Josh Sullivan from Seaport Global. Your line is now open.

Josh Sullivan, Analyst

Hey, good morning.

Michael J. Hartnett, CEO

Good morning, Josh.

Josh Sullivan, Analyst

Just on the aerospace side, to follow up on the various 737 shipping rates you mentioned. I think you said anywhere from 32 to 52 per month. Do your products carry large inventories? Or are these short cycle products? And I guess what I’m getting at, is there any preproduction inventory for these products, 32 per month, that’s pretty low – that still needs to be burned off at this point?

Michael J. Hartnett, CEO

Yes. I’m trying to think of the answer to that. We try to maintain an inventory position on most of these line items, so that we can ship them from stock and have MRP flexibility on the plant floor. I don’t see any burn-down issue. The issue is, if they turn the MAX on and it looks like it’s more and more likely to be sooner rather than later, are the inventory positions deep enough.

Josh Sullivan, Analyst

And then I think last quarter you mentioned the tightness in your markets here. Getting the 57 per month next year was a challenge. Do you still see that dynamic? Or do you think that can get out of 57 this year?

Michael J. Hartnett, CEO

I don’t see how that happens. I’m not a believer that it can get there. We’ll have the capacity to support it if they do get there. There’s an awful lot of subcontractors in the system here, and I suspect – I’m hearing that they still have shortages on the 737 on the current build rate.

Josh Sullivan, Analyst

Okay. Thank you for that detail. And then just switching gears over to the industrial side. What are your thoughts on the PCD bearing market? Is that an area where you guys have some applications? Are you seeing PCDs taking any meaningful share of traditional markets at this point?

Michael J. Hartnett, CEO

What’s a PCD?

Daniel A. Bergeron, CFO

I’m not sure we understand.

Josh Sullivan, Analyst

Yes. The synthetic crystal bearings that are coming to the market, particularly in some energy applications.

Michael J. Hartnett, CEO

No. I’d love to read about them. Maybe I’ll go to YouTube and see what those things are.

Josh Sullivan, Analyst

Got it. Thank you for the time.

Michael J. Hartnett, CEO

Yes.

Operator, Operator

Thank you so much. I’m showing no further questions at this time. I would now like to turn the call over to Dr. Hartnett.

Michael J. Hartnett, CEO

Okay. Well, thank you again for your interest in RBC Bearings and your participation in the call today. We look forward to speaking to you again in October.

Operator, Operator

Thank you so much presenters, and thank you for everyone who participated in today’s conference call. This concludes today’s conference. You may now disconnect.