Earnings Call Transcript - RBC Q3 2021

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the RBC Bearings Fiscal 2021 Third 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 hand the conference over to your host Michael Cummings with Alpha IR. Please go ahead.

Michael Cummings, Host

Good morning. Thank you for joining us for RBC Bearings fiscal 2021 third quarter earnings conference call. With me on the call today are Dr. Michael J. Hartnett, Chairman, President, and Chief Executive Officer; Daniel A. Bergeron, Director, Vice President and Chief Operating Officer; and Robert Sullivan, Vice President and Chief Financial Officer. Before beginning today's call, let me remind you that some of the statements made today will be forward-looking and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected or implied due to a variety of factors. We refer you to RBC Bearings recent filings with the SEC for a more detailed discussion of the risks that could impact the company's future operating results and financial condition. These factors are also described in greater detail in the press release and on the company's website. In addition, reconciliation between GAAP and non-GAAP financial information is included as part of the release and is available on the company's website. Now, I'll turn the call over to Dr. Hartnett.

Michael Hartnett, CEO

Thank you, Mike, and good morning. Net sales for the third quarter of fiscal 2021 were $145.9 million versus $177.0 million for the same period last year, a decrease of 17.6%. For the third quarter of 2021, sales of industrial products represented 44% of our net sales and aerospace products, 56%. Gross margin for the quarter was $55.6 million or 38.1% of net sales. This compares to $70.7 million or 39.9% for the same period last year. Adjusted operating income was $27.9 million or 19.1% of net sales compared to last year $37.8 million and 21.4%. Adjusted EBITDA was $41 million, 28.1% of net sales compared to $50.9, 28.7% of net sales for the same period last year. We ended the quarter with over $200 million in cash and marketable securities and roughly $20 million in debt. And year-to-date free cash flow was a record $102 million. We entered the second quarter with better visibility to customer requirements than past periods and saw an encouraging increase for product from industrial OEMs as well as stabilization of demand from the aircraft sector. We continue to work through an environment complicated by enhanced safety procedures to manage the COVID situation, and this environment has almost become normal practice for us today. Sales of industrial products were up 5.5% from last year and sequentially up 8.5%. Prime drivers in the industrial sector are the following markets; wind power, where the green revolution is generating a need for ever larger wind machines, some as large as 220 meters in diameter, which require advanced blade designs and machine mechanics leading to higher efficiencies. Number two is marine; the build-out of the Virginia submarine fleet with extended weaponry and the funding of the Columbia ballistic missile submarine is driving substantial need for hydraulic hardware and engineering support. Three is semiconductor; a greater use of computer chips in automobiles, phones, games, self-driving cars, and 5G technology has created shortages in this industry. Producers are expanding capital budgets like never before to protect their market positions. Finally, trains; the mass movement of people in Asia is a priority as China continues to pursue an extremely ambitious goal of connecting her cities with high-speed rail. We're working in all these markets today with proven products and solutions as well as new design proposals for problem-solving and acquiring new customers. Turning now to aerospace and defense, the third quarter of fiscal 2021, sales were down 29.7%. The abrupt suspension of the 737 MAX production in March resulted in excess inventory of aircraft hardware throughout the system, reflected in this exaggerated decline and will likely be with us for another quarter. We worked with customers during the second and into the third quarter to reschedule product deliveries; most of that, if not all, is behind us today. We are encouraged by the release of the MAX for commercial use, and our plans are now to support the Boeing build rate of between 150 and 160 MAX ships in calendar 2021 moving to over 300 in calendar 2022. We are very heartened to see a 10% expansion announced by Airbus in 2021 followed by a 20% expansion in 2022 for the A320 ship. Their plan to build almost 800 total ships in 2022 is inspiring to all of us. During the period, we consolidated plant operations into locations to streamline our cost structure and drive efficiencies of execution. We expect a little bit more of this in the future. Regarding our fourth quarter, we are expecting sales to be between $155 million and $160 million.

Robert Sullivan, CFO

Thank you, Mike. Since Mike has already covered net sales and gross margin, I'll jump down to SG&A. SG&A for the third quarter of fiscal 2021 was $25.7 million compared to $30.7 million for the same period last year. The decrease is mainly due to lower personnel costs of $4.4 million and $0.6 million of other items. As a percentage of net sales, SG&A was 17.6% for the third quarter of fiscal 2021 compared to 17.4% for the same period last year. Other operating expense for the third quarter of fiscal 2021 was an expense of $3.3 million compared to an expense of $2.5 million for the same period last year. For the third quarter of fiscal 2021, other operating expenses were comprised mainly of $2.6 million in amortization of intangible assets, $0.5 million of restructuring costs and related items, and $0.2 million of other items. Other operating expense for the same period last year consisted mainly of $2.5 million in amortization of intangible assets. Operating income was $26.5 million for the third quarter of fiscal 2021 compared to operating income of $37.5 million for the same period in fiscal 2020. On an adjusted basis, operating income would have been $27.9 million for the third quarter of fiscal 2021 compared to adjusted operating income of $37.8 million for the third quarter of fiscal 2020. For the third quarter of fiscal 2021, the company reported net income of $21.6 million compared to net income of $30.5 million for the same period last year. On an adjusted basis, net income would have been $22.7 million for the third quarter of fiscal 2021 compared to adjusted net income of $30.4 million for the same period last year. Diluted earnings per share was $0.86 per share for the third quarter of fiscal 2021 compared to $1.22 per share for the same period last year. On an adjusted basis, diluted EPS for the third quarter of fiscal 2021 was $0.90 per share compared to adjusted diluted EPS of $1.22 per share for the same period last year. Turning to cash flow, the company generated $36.1 million in cash from operating activities in the third quarter of fiscal 2021 compared to $46.6 million for the same period last year and $110.6 million in cash from operating activities for the nine-month period during fiscal 2021 compared to $111.2 million for the same nine-month period last year. Capital expenditures were $2.8 million in the third quarter of fiscal 2021 compared to $7.3 million for the same period last year. On a nine-month basis, capital expenditures were $8.8 million compared to $27.6 million for the same nine-month period last year. Total debt as of December 26, 2020 was $20.5 million, and cash and marketable securities on hand were $201.7 million. I would now like to turn the call back to the operator for the question-and-answer session.

Operator, Operator

Your first question is from Pete Skibitski with Alembic Global.

Peter Skibitski, Analyst

Good morning, everyone. It was a solid quarter. Mike, regarding the fourth quarter margin, it seems you are indicating that this will likely be your highest revenue quarter of the fiscal year. Do you also expect it to be your highest adjusted operating margin quarter, or do you anticipate some challenges with the mix?

Michael Hartnett, CEO

No, I think your earlier conclusion there was right. It'll be our highest margin, highest operating income quarter.

Peter Skibitski, Analyst

Okay. Got you. And then my other question was just your comments on the Boeing numbers, I think the 150 to 160, that must be new builds, as opposed to delivering from Boeing inventory. So, just on the timing, are you expecting to ship the majority of your deliveries on the MAX in the first half of the year on terms of that 150 to 160? And then the second half of your year, you start to deliver to that what they will deliver in 2022 until we have this building effect?

Michael Hartnett, CEO

You have that right. So, I think the first half of the year, we're going to be working on that. We're working through that 155, 160 rate kind of thing for calendar 2021, right. But that'll pretty much by July we'll be building into the 300 plus rate for 2022.

Peter Skibitski, Analyst

Yeah, okay. Last question for me is just on the aftermarket side. Does it feel like you have more visibility kind of forward six to 12 months on the OE side versus the aftermarket side? Just because we're kind of still in the doldrums traffic-wise? How are you guys thinking about the predictability of your aftermarket revenue in the mid-term?

Michael Hartnett, CEO

The aftermarket revenue operates on a short cycle basis, and there isn’t typically much backlog. The key factor in this industry is the turnaround time from when we receive the order to when we provide the hardware and ship it back. While there isn't much backlog in the aftermarket, we are witnessing a return of strength in that area.

Peter Skibitski, Analyst

Okay. That's why I think a lot of people are wondering, we know we've seen so many retirements of older aircraft, people are wondering if they'll be sustained aftermarket bathtub, if you will, but it sounds like you don't subscribe to that view, per se.

Michael Hartnett, CEO

Many carriers have reduced their maintenance departments and are now seeking third-party support to service their planes. This is creating a positive opportunity for us.

Peter Skibitski, Analyst

Okay, okay. Great. Thanks for the color, guys.

Operator, Operator

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

Steve Barger, Analyst

Thanks. Good morning. Really nice to see a return to growth for the industrial business, are you expecting another mid-single-digit increase in 4Q?

Michael Hartnett, CEO

Yes, we are. 4Q is doing very well on the industrial side.

Steve Barger, Analyst

So, as I think about that, in the context of your guidance that suggests another maybe mid-20% decline for aero. And just as I think about how that flows into the next fiscal year, just looking at the comps, would you expect that 1Q is still down on aero and then you get back to growth in 2Q, 3Q, 4Q?

Michael Hartnett, CEO

That's pretty much how we're starting to see it. There are some unusual developments occurring as Boeing is currently going through contract cycles with their subcontractors and making changes. We provide products to these subcontractors under negotiated contracts. The new subcontractors who are receiving contract awards starting in 2022 are just now settling in and are not fully aware of their requirements for our types of products. This is causing a delay between the time they receive their contracts and when they actually place orders with us, leading to some uncertainty. Ultimately, they will require products in a timeframe that is shorter than the lead-time for our bearings and other structural components, which will create some day-to-day challenges. We are working to manage this situation across all our divisions that support this sector, ensuring we remain aligned with our product mix, content per ship, ship build rates, and the needs of the new contract holders to avoid any shortfalls. This is a typical occurrence over a five-year cycle when supplying a major OEM like Boeing.

Steve Barger, Analyst

So, should my takeaway be that your fiscal 1Q 2022 doesn't necessarily have to be negative, it actually could be positive, if they pull that forward, or that actually 2Q could be negative like 1Q, while they kind of work it out?

Michael Hartnett, CEO

I don't expect Q2 to be negative because the lead times won't meet Boeing's requirements, which will be an issue for everyone. Everything will be sorted out eventually, but for now, we will be in a difficult situation. I don’t anticipate that Q1 will decline as much as Q4, considering the build rate we need to support in 2022.

Steve Barger, Analyst

Right. Because you'll be shipping those six or nine months early, right? Those parts for the 2020, got it.

Michael Hartnett, CEO

Exactly. Okay, so 1Q down, but then growth resuming after that, and presumably you have the expectation that you're looking at positive growth for the entire fiscal year for 2022 on the industrial side, just given how those trends are going. Correct.

Steve Barger, Analyst

Okay. And so as I think about that volume coming back on both sides, FY 2021 will be down maybe 150 basis points on operating margin versus FY 2020. As you think about growth coming back and managing SG&A, how much of that 150 basis points that you lost do you think you can recover in FY 2022?

Michael Hartnett, CEO

Well, let's hope we can recover it all, right. And let's create a process that's better than hope.

Steve Barger, Analyst

Right on.

Michael Hartnett, CEO

So, I think right now the margins are down the amount that you reference there, largely because we see the industry coming back and the demands coming back on us. And so we're retaining as much human capacity as we can possibly retain to be able to support the market on the other side of this. And so that's really our strategy. So, we should be able to back into those new revenues and recover the margins. That's the theory.

Steve Barger, Analyst

Okay. I have one more question before I return to the queue. We've discussed the M&A pipeline every quarter, and your balance sheet looks great with plenty of cash. Can you update us on your discussions with some of these private companies? Additionally, are there any smaller public companies you might consider acquiring?

Michael Hartnett, CEO

Yes, we're actively pursuing acquisitions and are engaged in discussions with potential candidates. We've been making proposals, but we haven't successfully closed any deals yet. The competition for these assets is quite fierce, and while we're participating and offering competitive bids, we haven't secured any wins.

Steve Barger, Analyst

Just because there are other sources of funding that are more aggressive or generous than ours, it raises the question of whether we can compete.

Michael Hartnett, CEO

Yeah. Well, exactly, and I'd say we're pretty generous.

Steve Barger, Analyst

Understood. Thanks. I have some more. But I will get back in line.

Operator, Operator

And your next question is from the line of Michael Ciarmoli with Truist Securities.

Michael Ciarmoli, Analyst

Mike, are you there? Hello.

Operator, Operator

Michael, your line is live.

Michael Ciarmoli, Analyst

Sorry, guys. I was on mute. Morning guys. Thanks for taking the questions. Mike just to stay on what Steve was just hitting on M&A, sounds like that there's a lot of, I guess, aggressive valuations being applied out there. But maybe in the absence of any deal flow here, you certainly have a lot of dry powder. Are you thinking about anything else in the way of capital deployment, whether it's buyback, dividend, or are you guys just laser focused on M&A?

Michael Hartnett, CEO

Yes, we're pretty laser-focused on M&A. There's some really attractive candidates out there that would substantially add to our market positions. And so we're really focused on those candidates.

Michael Ciarmoli, Analyst

Is it related to the size? Are you observing tightness or increased competition in all sizes of deals, or are you aiming for something that would make a more significant impact?

Michael Hartnett, CEO

Yes, I mean, we haven't really gone after the smaller size deals. The larger ones attract a lot of attention.

Michael Ciarmoli, Analyst

Got it. Okay. Going back to the margin side, as we approach the end of fiscal 2022, do you believe you can return operating margins and gross margins to the levels seen in fiscal 2020? You've certainly increased capacity to support production rates in aerospace, which may not align with fiscal 2022. Do you foresee any profitability constraints due to excess overhead or stranded costs, especially since Boeing and Airbus may be operating below your capacity?

Michael Hartnett, CEO

No, we don't have the stranded cost issue that some companies face. We're not involved in the steel industry, so we don't have to maintain constant temperatures for furnaces, and we don't encounter those types of challenges. Our costs are very variable. The reason our margins are where they are today is that we're maintaining resources in place to support potential growth. It doesn't make sense to reduce the capabilities of a company we've built over many years just because of one pandemic year.

Michael Ciarmoli, Analyst

Yes. No, that's fair. Just last one I had. I mean you guys sound a lot more confident on production rates for the MAX, I mean, Boeing was kind of hesitant to say where they're even producing certainly they've got this aspiration to get to 31. Airbus kind of just dialed back their plan to get to 47. What's really given you this, this clear line of sight to 155 160 and kind of 300 plus next year?

Michael Hartnett, CEO

We have a significant team analyzing these numbers because they are crucial to us. Boeing publishes their skyline chart, which we analyze, and it is available for up to 24 months. We need this information to decide how to manage our resources and staffing in our facilities. This guidance is essential for the entire industry; without it, I don't see how Boeing could secure the support necessary to build an airplane.

Michael Ciarmoli, Analyst

Okay.

Michael Hartnett, CEO

We're just benefitting off of information that has slowed down to us.

Michael Ciarmoli, Analyst

As we discuss the aerospace trajectory, it's clear that the content related to wide-body aircraft is significantly higher than it was a couple of quarters ago, particularly with the 777X, which has been delayed further. This raises uncertainties about the recovery of the wide-body market. Is the skyline for wide-bodies providing you with any insights or confidence regarding the current rates? Additionally, do you expect the volume of your shipments to remain stable at these rates, or are you anticipating any increase in the wide-body platforms to which you have exposure?

Michael Hartnett, CEO

I believe the return of wide-body aircraft will come after the pandemic is over, which likely has a couple of years before it happens. Therefore, the focus is on the MAX. The increase in MAX production will be the main driver of our revenue in the aircraft segment, while the 787 will see a reduction, and the 777X will be delayed by a few years. It's crucial for the MAX production to meet Boeing's targets, especially since Airbus is increasing production by 10% and aiming for 800 planes, which doesn't negatively impact us. It appears that Airbus will fully recover by 2023. For Boeing, it may take until 2025 to return to the numbers from 2019.

Michael Ciarmoli, Analyst

Got it. Okay. All right, perfect. Thanks guys. I'll jump back in the queue here.

Operator, Operator

Your next question is from the line of Joseph Ciarleglio with Bradley, Foster & Sargent.

Joseph Ciarleglio, Analyst

Good morning guys. Thanks for taking my question.

Michael Hartnett, CEO

Good morning.

Joseph Ciarleglio, Analyst

I'm just wondering how the shift of a portion of RBC back office engineering and R&D functions to Poland, how that's progressing? And how you're sizing up the potential cost savings from these efforts? So, in other words, should this accretive margins begin in fiscal year 2022 or is it more of a fiscal year 2023 story? Thank you.

Michael Hartnett, CEO

It's definitely not a fiscal 2022 story. The challenge is that we can't easily travel to Poland, and accessing some of those countries is difficult. This has caused delays in our ability to interview and onboard new hires. Consequently, we are likely hiring only about 10% of the personnel we intended to bring on this year. However, we are continuing to advance the entire program, so it’s more of a 2023 narrative.

Joseph Ciarleglio, Analyst

Great. Thank you.

Operator, Operator

Okay. I am showing no further questions at this time. I would now like to turn the conference back to Dr. Hartnett.

Michael Hartnett, CEO

Thank you for joining the call today. I hope it was beneficial for everyone. We are currently in the midst of a successful fourth quarter and will reconnect with you in May. Thank you once more.

Operator, Operator

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