Earnings Call Transcript - RBC Q2 2020

Operator, Operator

Good day ladies and gentlemen and welcome to the RBC Bearings Fiscal 2020 Second 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 follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Chris Donovan with Alpha IR. Sir, please go ahead.

Chris Donovan, Host

Good morning and thank you for joining us for RBC Bearings fiscal 2020 second 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 applied 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 Hartnett, CEO

Thank you and good morning. Net sales for the second quarter of fiscal 2020 were $181.9 million versus $172.9 million for the same period last year, a 5.2% increase. Organic growth for the quarter was 6.8%. For the second fiscal quarter of 2020, sales of industrial products represented 35.5% of our net sales with aerospace products at 64.5%. Gross margin for the quarter was $71.1 million or 39.1% of net sales. This compares to $67.8 million or 39.2% for the same period last year, a 4.9% increase. Operating income was $37.3 million versus $35.9 million last year, a 4% increase. EBITDA was $51.2 million versus a 7.7% increase over last year. We were pleased with the performance this quarter and continue to be encouraged with a strong outlook for our aircraft businesses and are seeing positive signs as early as the fourth quarter in some of our industrial markets. Sales of industrial products over the period were down 5%, last year the expansion was 7%, so we were up against some difficult comparisons. Industrial OEM was down 4% and distribution in aftermarket was down an organic 7.2% on a year-over-year basis. Aerospace and defense markets paint the opposite picture. The second quarter organic net sales were up 14.4%, aerospace and industrial markets today are quite different. Aerospace sales were driven by OEM and aftermarket. Aero and defense OEM were up 15.1% on an organic basis. Supply chain constraints, both internal and external, continued to ease as we bring new capacity and approvals online. Some plants continue to be production constrained and we will continue to add capacity in these areas. The sector is likely to continue to perform at the double-digit growth level for the next several quarters as we introduce additional manufacturing capacity and convert new contracts to revenues. At this point in our year, as we enter our third quarter, most of our aerospace businesses are booked well into 2021. When the 737 Max receives its FAA certifications, we hope in calendar Q4, and production is accelerated. We expect our aircraft products' growth rate to steepen further. Today, we are beginning to see the impact of the Max in the third quarter outlook as we are starting to feel the effects of the reduced production rate for that plane at plants where production is not constrained. We continue to add both capacity and new processes in support of our customers' requirements and should be well positioned in this regard for FY '21 and beyond. Regarding our second quarter, we are expecting sales between $177 million and $179 million, which results in an organic growth rate of approximately 4% over last year. I will now turn the call over to Dan for more details on the financial performance.

Dan Bergeron, CFO

Thanks, Mike. SG&A for the second quarter of fiscal 2020 was $30.8 million compared to $29.3 million for the same period last year. The increase was mainly due to $1 million of additional incentive stock compensation, higher personnel costs of about $0.4 million and $0.1 million of other items. As a percentage of net sales, SG&A was 16.9% in the second quarter of fiscal 2020 compared to 17% in the same period last year. Other operating expense for the second quarter of fiscal 2020 was an expense of $3 million compared to an expense of $2.6 million for the same period last year. For the second quarter of fiscal 2020, other operating expenses were comprised mainly of $2.3 million in amortization of intangible assets and $0.9 million of acquisition costs offset by other income of $0.2 million. Other operating expense for the same period last year consisted mainly of $2.6 million in amortization of intangible assets. Operating income was $37.3 million for the second quarter of fiscal 2020 compared to operating income of $35.9 million for the same period in fiscal 2019. On an adjusted basis, operating income would have been $38.4 million for the second quarter of fiscal 2020 compared to adjusted operating income of $35.9 million for the second quarter of fiscal 2019. For the second quarter of fiscal 2020, the company reported net income of $31.3 million compared to net income of $30.1 million for the same period last year. On an adjusted basis, net income would have been $32.3 million for the second quarter of fiscal 2020 compared to adjusted net income of $30.2 million for the same period last year. Diluted earnings per share was $1.26 per share for the second quarter of fiscal 2020 compared to $1.22 per share for the same period last year. On an adjusted basis, diluted earnings per share for the second quarter of fiscal 2020 was $1.30 per share compared to an adjusted diluted EPS of $1.22 per share for the same period last year. Turning to cash flow, the company generated $24.5 million in cash from operating activities in the second quarter of fiscal 2020 compared to $24 million for the same period last year and $64.6 million in cash from operating activities for the six-month period of fiscal 2020 compared to $57.9 million for the six-month period last year. Capital expenditures were $8.2 million in the second quarter of fiscal 2020 compared to $10.8 million for the same period last year. On a six-month basis, CapEx was $20.2 million compared to $17.7 million for the same period last year. In the second quarter of fiscal 2020, the company paid down $13.1 million of debt and for the six-month period we paid down $30.2 million of debt. Total debt as of September 28, 2019 was $37.8 million and cash on hand was $36.4 million. I'll now turn the call back over to the operators to begin the Q&A session.

Operator, Operator

And your first question comes from Pete Skibitski with Alembic Global.

Pete Skibitski, Analyst

Good morning guys. I just want to get a sense of how you're seeing operating margins in the second half of the year. It looks like in the first half, you're up year-over-year. In the second half, I think it's a little tougher comp-wise on the margin side, but it looks like you're feeling good about volumes. So, should we expect margins to be up period-over-period in the second half and kind of how much are they tied to whether or not we can have the Max return to service?

Michael Hartnett, CEO

Yes. Well, at the beginning of the year we gave guidance of a 50 basis point increase in gross margins. So, for the first six months this year we're at 38.9% compared to 38.9% last year. So, we're a little short on the target for gross margin, but we were able to keep the costs in mind. So on adjusted operating income year-to-date, we're at 21.1% compared to last year, 20.6%. So, we're seeing a 50 basis point improvement. I think that's going to stay steady through the year. I think we'll see the margins improve going into Q3 and Q4, and we'll also try to keep the costs under control. But I think we're comfortable with the 50 basis point improvement falling down to operating income.

Pete Skibitski, Analyst

Okay. Sounds great. And then, Mike, can you maybe expand on your comments about green shoots in industrial, maybe starting to do more in the fourth quarter or are those, maybe certain subsectors within industrial showing signs?

Michael Hartnett, CEO

Well, there's a couple of factors going on in the industrial sector. Right now, as we approach our third quarter, or the calendar year fourth quarter, many companies are trying to manage their inventories to a certain objective that they had set for their bonuses. Inevitably, the businesses can't operate with that artificial level of working capital. So, every year what you see is in our fourth quarter, calendar first quarter, all these companies ramp up in terms of replenishing inventory so they can run their businesses properly. That's just standard operating procedure in the industrial world for us. In addition to that, we have some new contracts coming in on existing accounts which are very promising and will bring us some increased volumes in industrial next year. We also have some new contracts on new accounts which are equally promising. We're seeing a pickup in demand overall.

Pete Skibitski, Analyst

That sounds great. And is that incremental to, I think you've been expecting the submarine business to get better next year? So the commentary you just gave is kind of in addition to the submarine optimism?

Michael Hartnett, CEO

That has nothing to do with the submarine business. That's just...

Pete Skibitski, Analyst

Great. Okay. Gentlemen, last question for me. Mike, you're talking about inventory. It looks like, and maybe this is more for Dan, but it looks like you guys have built a lot of inventory yourselves this quarter and through the first half of the year. Should we expect that to reverse maybe not in the third quarter but by the fourth quarter?

Dan Bergeron, CFO

Yes. It's been slowing down, decelerating as we move into this year. By September, we're going to file the Q this afternoon, but we ended September with $353.9 million in inventory compared to the year end of $335 million. Some of this is backing off on the industrial side, and some of it is being offset by builds on the aerospace side.

Operator, Operator

Your next question comes from the line of Kristine Liwag with Bank of America.

Kristine Liwag, Analyst

Hi, good morning guys. Mike, last quarter you mentioned for the 737 that you're producing generally at 42 per month with some at 52 and some at 32. With your commentary today, it sounds like there's a change with that production rate. Can you give more color on where you are today? And then also, how is your supply chain coping with lower 737 volumes than previously anticipated?

Michael Hartnett, CEO

Well, we are relative to the supply chain. We are the supply chain. So we're coping just fine. I think what we see is, depending upon which products are being produced in each of these products have come from a different plant. What we're seeing is, some sectors of the aircraft business are running at 52, some are running at a little more than 52, and some are in the high thirties. You can see this widespread demand for these planes. In one of our plants where capacity is being throttled by the Max demand, it creates a few million dollars in our quarter, and we're believers that the Max will return to production someday and this all gets corrected. But in the plants where we're production constrained, we're using this interim period to catch up. Did that answer your question or did we get off track?

Kristine Liwag, Analyst

Well, I guess it's more about the production. I guess the nature of my question is just understanding where you are today and how this lower volume could affect your margin outlook for the year. Also, if you're seeing some suppliers, how they're coping, are we going to see bottlenecks in the future once the airplane goes into service?

Michael Hartnett, CEO

Well, there are serious bottlenecks now in the sector. That's the reason we built a new plant, and that's why we installed a lot of these special processes in the plant. We're going through the approval cycle now and one by one we'll be able to turn these processes on and use them for internal production to bypass the constraints that a lot of the industry is feeling that relies on subcontractors. So if the 737, and when the 737 comes back into production, the timing is going to be just perfect for us in terms of internal production for these products. If the Max is delayed through our fourth quarter, which is the calendar first quarter, it'll probably have a couple of million dollars more impact on our revenues. If it's not delayed, the plants that aren't constrained will have a great day, and the plants that are constrained will be coming out of that constraint problem soon. I think we're going to be well positioned to service that business, certainly by the end of our fourth quarter.

Kristine Liwag, Analyst

That's really helpful color. In your general industrial business, can you talk about the end markets and what you're seeing in terms of growth and order activity?

Dan Bergeron, CFO

Yes. So Kristine on the industrial side for the quarter, we were down about 2.8% and organically about 5%. If you exclude the Swiss Tool acquisition, we recently completed, the major driver was the oil and gas sector which was down 54% in the quarter and accounted for about $1.8 million of sales. If we remove that from the equation, we would have been basically flat year-over-year on our industrial sales. The slow points we're seeing in Q2 are primarily in oil and gas, mining, and general industrial distribution where companies are correcting their inventories. The positive signs we noted on the industrial side were in semiconductor equipment and on our marine sector.

Kristine Liwag, Analyst

Thank you very much.

Operator, Operator

Your next question comes from the line of George Godfrey with CLK.

George Godfrey, Analyst

Good morning. Thank you for taking the question. I heard all the comments about the production of the Boeing 737 Max returning, but I want to get some thoughts on a more pessimistic outlook. Have you considered what it would mean for your business and supply chain if production were to drop to 10 or 15 planes or if the return to service is pushed out to next summer? Thanks.

Michael Hartnett, CEO

Well, our business dimensions are far beyond the 737 Max. Although the 737 Max is an important contributor, it's no secret we have more than $100,000 per plane. A delay in production wouldn't be great news, but we'd get through it. There are other programs that are proceeding, and when one door closes, another opens.

George Godfrey, Analyst

And if the Max started winding down or production had to go down in the A320 Neo, would you be prepared to address that?

Michael Hartnett, CEO

Yes. The Neo and the Max use the same kind of product that we produce. They have different part numbers, but basically the same bearing in many cases. So, a lot of that mix is the same. Some of that mix is different, so it isn’t all a generic mix.

George Godfrey, Analyst

Got it. In the press release, you mentioned there will be four or five fewer production days in the current quarter. But relative to last year, there would be no difference in the days, correct?

Michael Hartnett, CEO

That's correct. There was no difference last year.

Operator, Operator

Your next question comes from the line of Josh Sullivan with Seaport Global.

Josh Sullivan, Analyst

Good morning. Can you talk about the 787 program? Is that a large program for you? Have you seen that working its way through the supply chain on the cuts? Where do you think you are on the 787 at this point?

Michael Hartnett, CEO

The 787 is also equally important for us. I think I heard they are backing off one ship per month. I think that's correct.

Josh Sullivan, Analyst

It’s actually two.

Michael Hartnett, CEO

Yes. It doesn't have much of an effect on us. Particularly if the Max replaces it, and if the 777X comes onboard in a reasonable timeframe, we will have our hands full.

Dan Bergeron, CFO

And the most important platform for us would be the 777X.

Josh Sullivan, Analyst

Have you seen any changes in the timeline for that program right now?

Michael Hartnett, CEO

Yes. We've seen some delays, but at the same time, they're ramping up the 777 to accommodate their market demand. Our content on the 777 is very good. Our content on the 777X is probably 50% better.

Josh Sullivan, Analyst

Switching over to the submarine business, I think earlier this year there were some timing delays just on the Block 5 changeover. Do you see any changes to that progression going forward? Has it accelerated? Does the CR have any impact on that?

Dan Bergeron, CFO

I think it's right on time where we thought it would be. We're going through final terms and conditions negotiations, and we should be in pretty good shape.

Josh Sullivan, Analyst

All right. Thanks for the time.

Operator, Operator

Your next question comes from the line of Michael Ciarmoli with SunTrust.

Michael Ciarmoli, Analyst

Hey, good morning guys. Thanks for taking the question. Just on aerospace, I mean, the 787 is down, the 777X is getting delayed. If the 737 never goes to 57 a month, how are you guys looking at the potential overhead absorption issues with lower volumes?

Michael Hartnett, CEO

We don't see that scenario developing for us. We have only one facility that is being affected by the 737 Max slowdown. The other facilities are very much, as I said, production constrained. Yes, if the Max doesn't come back into service, it would be a disaster for the industry, but I think the likelihood of that is zero. I think they'll resolve the issues. It's just a matter of timing.

Michael Ciarmoli, Analyst

When you say, if the Max is delayed more, if we get a return to service later, December or February, if they opt not to take the rate to 57 and hold at 42, does that keep the headwind on you guys?

Michael Hartnett, CEO

No. I don’t think that. First of all, I don't think the supply chain is capable of making 57 notwithstanding their optimism. I think the supply chain would have a great deal of difficulty maintaining 52; our models for next year are based around 52. If it's more, it’s better; if it's less, we'll deal with it. So that's kind of where we are right now. And I think the whole industry is waiting for the next shoe to drop on the program.

Michael Ciarmoli, Analyst

Got it. And one more on that topic: you guys talked about that you were picking up some share. Is that still the case? Is that softening the impact of lower rates?

Michael Hartnett, CEO

Yes, that's definitely mitigating the volumes. That's one of the reasons why we're facing production constraints in some of our facilities, as our competition is having difficulty getting products to their plants.

Operator, Operator

Your next question comes from the line of Steve Barger with KeyBanc Capital Markets.

Steve Barger, Analyst

Hey, good morning. I wanted to return to the industrial inventory commentary and the idea of replenishment. Can you remind us of your exposure to things like off-highway and construction equipment? We’re seeing sizable year-over-year order contraction that will lead to lower production next year in some end markets, and that should flow through into general industrial and distribution.

Michael Hartnett, CEO

We don’t have the degree of exposure that Timken seems to have. It's a smaller sector for us, but it’s meaningful. I think Dan has the current numbers in that sector rather than I do, so I'll let him speak to it.

Dan Bergeron, CFO

Yes. For us in that sector, it’s mainly the big hauling trucks where we have a lot of our content. It’s mostly driven by mining activity and commodity activity in the mines.

Steve Barger, Analyst

Okay. So not much exposure to traditional construction equipment?

Michael Hartnett, CEO

Well, we have exposure to it, but it's not a sizable market like we would see in heavy haul and mine trucks.

Steve Barger, Analyst

Right, so more in line with oil and gas as you described earlier?

Dan Bergeron, CFO

Yes, probably in that range of a $5 million to $10 million type market.

Steve Barger, Analyst

Got you. And switching gears, can you talk about the strategic rationale for buying Swiss Tools?

Michael Hartnett, CEO

Yes. What would you like to know?

Steve Barger, Analyst

It looks like a niche supplier of tools for turning and boring. How does that fit with your portfolio?

Michael Hartnett, CEO

Well, we manufacture tools for turning and boring and grinding and machining in Switzerland. We like that market. It's a market that, yes, it's definitely a razor blade market. We like markets where you sell a product once and it has to be replaced multiple times in its life cycle before a new product replaces it. That's the nature of that product level, and we like that sector and intend to engage further.

Steve Barger, Analyst

So this is really a market consolidation and scale play?

Michael Hartnett, CEO

Well, it is a market where we feel we know how it operates, the players, and the necessary manufacturing technologies to support it. We look for companies with strong, defensible franchises in those markets.

Steve Barger, Analyst

And can you talk about the margin profile?

Michael Hartnett, CEO

Big.

Steve Barger, Analyst

Is it accretive to corporate?

Michael Hartnett, CEO

Yes, substantially.

Operator, Operator

And at this time we have no questions. I would now like to turn the conference back to Dr. Hartnett.

Michael Hartnett, CEO

Okay. Well, thanks once again for participating in our conference call, and that completes the call for the second quarter. We look forward to talking to you again in January. Good day.

Operator, Operator

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.