RBC Bearings Inc (RBC) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2011 RBC Bearings earnings conference call.

My name is Angela and I will be your coordinator for today.

(Operator Instructions).

And now I'd like to turn the conference over to your host for today, Mr.

Adam Sigel, Financial Dynamics.

Please proceed.

Good morning and thank you for joining us today for RBC Bearings' fiscal 2011 third quarter earnings conference call.

On the call today will be 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 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 would like to now turn the call over to Dr.

Hartnett.

Thank you, Adam.

Good morning.

I'm pleased to report that our third quarter of fiscal 2011 showed continued year-over-year improvement in order volumes and sales in most market segments.

Our diversified industrial markets continue to see a terrific demand.

During the third quarter our sales were $81.3 million, an increase of 20.4% from the same period last year.

This was right in line with our internal forecast and the comments that I made in our Q2 earnings call a few months back.

Adjusted operating income was $12.9 million versus $8.9 million a year ago.

This was a 269 basis point improvement year-over-year.

Cash flow from operations was strong at $14.7 million for the third quarter of fiscal 2011 compared to $13.6 million during the same period last year.

We ended the quarter with $60.8 million of cash and short-term investments, and $31.4 million in debt.

Our conversion to net income to cash on a year-to-date basis was the following; $1.00 of net income resulted in $1.32 of free cash flow year-to-date.

The strength in our industrial markets continued through the third quarter, with sales for our industrial products to OEM were up 44% year-over-year and sales to industrial distribution followed with an 18.5% increase on the same year-over-year comparison.

These markets are responding well to our product offering, engineering problem solving and the repositioning of our industrial sales team.

Orders for the quarter were $88.4 millionversus sales of $81.3 million gave us a very favorable book to bill ratio.

Clearly we could have sold more in the third quarter, but there were six fewer days this quarter than in the second quarter and many holidays impaired our operating performance.

This is normally the case during this period and it was reflected in our discussion last quarter.

Sales from industrial products for this period represented 51% of our total revenue.

Just as we mentioned last call the message is the same.

We remain encouraged by the continued strength of our industrial markets and are now seeing more normalized demand for these products.

As a result, we are planning for continued strong demand for our bearings from large construction and mining equipment makers, industrial distribution, semiconductor machinery, military vehicles and consumables for machine tool products.

Our aerospace and defense market grew 2.6% in the quarter, compared to the same period last year, and this is the second quarter-over-quarter of sequential growth.

We saw 2.5% growth in our sales in the third quarter versus the second quarter,and remember this is with 10% fewer operating days.

We see continued positive developments in the aircraft markets, and the cadence in the industry is definitely increasing.

Our offices are full of proposals for products for both existing and new equipment for US and European manufacturers.

New multi year contracts are being negotiated and concluded.

The environment is very similar to the 2005 to 2007 era as the industry tools for the next up cycle.

Beginning this quarter we have seen considerable improvement in our sales to our aircraft after market distributors.

Sales to these customers were very strong up almost 50% sequentially with the capacity to double again from this base.

This strength is partially offset by the weakness in government products sector which we feel has bottomed and should now show sequential strengthening.

We ended the third quarter of fiscal 2011 with $180 million in backlog compared for $155.6 million for the same period last year, and $157.9 million for the fiscal year ended 2010.

Gross margin performance for the third quarter on an adjusted basis was 32.7% compared to 31.2% for the same period last year.

This is an improvement of 1.5 percentage points better than last year's third quarter.

As I said in our previous calls, I expect these improvements to continue throughout the remaining year and into next year.

We are seeing real improvement at the plant level margins as a result of process initiatives renewed at the beginning of the year, and expansion of our five [S] programs to new sites.

These margins will migrate through to operating margin improvements as they turn through the inventories.

Adjusted operating income was 15.9% of sales versus 13.2% last year.

This is a 269 basis point improvement for third quarter year-over-year and a 350 basis point improvement for nine months this year versus nine months last year.

We expect to see continued improvement in operating income line to strengthen our execution, as well as the volume leverage built into our cost structure.

Looking ahead, we expect the fourth quarter of fiscal 2011 to close the year as our strongest quarter with the continued improvements falling to the operating income line.

I'll now turn the call over to Dan, who will provide more color on this best period.

Thanks, Mike.

Since Mike's already discussed sales and gross margin, I'll jump down to SG&A.

SG&A put a third quarter fiscal 2011 increased $1.4 million to $13.3 million compared to $11.9 million for the same period last year.

As a percentage of net sales SG&A was 16.4% for the third quarter fiscal 2011 compared to 17.7% for the same period last year.

The increase in SG&A year-over-year was mainly due to an increase in personnel related items, higher professional fees and an increase in incentive stock compensation expense.

For the nine months ended January 1st, 2011, SG&A as a percentage of sales was 15.7%, compared to 17.8% for the same nine-month period last year.

And as I discussed on the conference call for Q2, we expect that SG&A number to be in between 15.5% to 16% for the full year, so we are pretty much right in that range that we discussed on Q2.

Other than that for the third quarter fiscal 2011 was a loss of $0.4 million compared to a loss of $0.4 million for the same period last year.

This is mainly all comprised of amortization of intangibles.

Operating income was $12.2 million for the third quarter fiscal 2011, an increase of 49.9% compared to operating income of $8.1 million for the same period in fiscal 2010.

Operating income, excluding costs associated with the expansion to our large bearing products and some small restructuring and moving costs, was $12.9 millionan increase of 45% compared to an adjusted operating income for the same period last year of $8.9 million.

For the third quarter fiscal 2011 the Company reported net income of $7.4 million compared to net income of $5.2 million for the same period last year.

Diluted earnings per share was $0.33 for the third quarter fiscal 2011 compared to $0.24 per share for the same period last year.

Adjusted net income was $8.1 million in the third quarter fiscal 2011 compared for an adjusted net income of $5.6 million for the same period last year.

Diluted earnings per share adjusted was $0.37 for the third quarter fiscal 2011 compared to $0.26 per share for the same period last year.

Turning to cash flow, the Company generated $14.7 million in cash from operating activity in the third quarter fiscal 2011 compared to $13.6 million for the same period last year.

Our capital expenditures were $2.7 million compared to $1.5 million for the same period last year, and we're expecting to end the year with capital expenditures in the range of $10 million to $12 million.

Total debt for the period ended January 1, 2011 was $31.4 million compared to $53.7 million for the same period last year, and the Company ended the quarter with $60.8 million in cash and short-term investments on the balance sheet which exceeds our total debt by $29.4 million.

I would now like to turn the call back to the operator to start the Q&A session.

Thank you, sir.

(Operator Instructions).

Gentlemen, your first question will come from the line of Edward Marshall with Sidoti & Company.

Please proceed.

Good morning.

I was curious.

Can you quantify the degradation of the gross margin sequentially due to the lower absorption of seasonal factors in the quarter.

Have you been able to look at it that way?

No, Ed.

For Q3 the margins came out 31.95% compared to Q2 of 32.78% and Q1 of 31.87%.

Right.

So some of that is mix and some of it is absorption related and some is related to the under absorption from our Houston facility for large bearings.

Right.

Right.

But looking on a pro forma basis, it's a slight step down.

And normalizing for seasonal days or looking at your days, selling days, I mean sales were up on a selling day basis.

I am just wondering.

I mean a portion of that is obviously to the absorption.

I'm wondering if you're able to quantify that from maybe a dollar value to see what degradation that put on the gross margin.

It doesn't seem like you went through that math.

No, we didn't, Ed.

But you have to -- with 10% fewer operating days on average, and basically the major overhead expense in the plants are fringe benefits and salaries, and then rent and utilities.

And all that is almost constant quarter-to-quarter, so there's real impact there.

Right.

I mean it sounds like that was a big piece of the step-down in the margin.

Yes.

And remember on the last conference call, we set the target for the year was to be around 32.5%, and on the year-to-date basis for unadjusted at 32.2%.

Right.

So I think we're right in the target range of where we expect it to be for the quarter and for the year.

Is there any adjustment now as you look forward into the fourth quarter, your seasonal strongest.

Is there any adjustment to the comments that you made 32.5% for the full year on the gross margin?

Do you think you can surpass that?

Well, we'll certainly try.

But there's a lot of math between here and there.

Okay.

You made a comment in your prepared remarks about the aerospace after market and you said something about 50%.

Did you say orders were up 50% or did you say sales were up 50% in the aerospace after market?

It was sales during the quarter.

It was shocking, really, when we went back through the numbers.

Because when you're running this on a day-to-day basis you rarely step back and say what segment is performing like that.

But when we totaled the numbers, clearly the second quarter numbers showed no improvement year-over-year in terms of aircraft sales to the aircraft after market, and the third quarter number showed a 50% increase in sales to the after market.

Almost turned on like a switch in the third quarter.

Interesting.

Now can we relate that to the backlog, if I could for just a moment.

Because I think that's largely aerospace related and the rate of growth slowed again in this particular quarter.

Is it because you basically were able to ship -- as the orders came in you were able to ship to the aerospace segment relatively quickly, or what caused the sequential slowdown in growth rate from second quarter to third quarter in the backlog?

As far as the rate of growth was concerned.

I think I mentioned it in the introduction.

In the previous quarters, we saw extraordinary demand for the industrial products and for ground defense.

And now that demand has normalized and we're seeing more normal demand for industrial products and ground defense.

The demand profile has switched over to the aircraft sector.

Can you spend a minute and talk about ground defense and maybe what's the customer there?

What you expect.

Because I think there's a couple military vehicles that are being built in pretty high volume this coming year.

Can you talk about what you think there?

And describe a little bit further about the military vehicle segment and how you're related to it.

Yes.

Well we make bearings for the military ground vehicles.

Without being too specific here, Ed, and pointing all of my competition to my business, but we do see what you see in terms of the new builds, of equipment that are due to take place in calendar 2011.

We're well represented on most of that machineryand we're waiting to see whether or not the actual defense contracts are released.

Some of them are being released on a partial basis for field retrofit.

And so we're enjoying some of that now,but the big new OEM builds, to my knowledge, have not been released by the defense department yet.

So just be clear, you're on both the recap or the retrofit as well as the new builds as well?

That's correct.

Thank you very much, guys.

And, gentlemen, your next question will come from the line of Steve Barger with KeyBanc Capital Markets.

Hey, good morning guys.

Good morning, Steve.

A little more color on the SG&A increase.

The last time you ran to that level on a dollar basis was a quarter or two back before the downturn, a couple of years ago, when you were doing in the low $90 million range for sales.

Is this really just hiring designed to drive future sales, or what were the personnel related items?

I'd say it's both.

Some of it is increase in capacity for future sales.

And some of it is just variable cost that's coming back from things that we did last year to take costs out that weren't permanent changes to the structure.

And that's about it.

I mean, it's not a big jump from Q2.

Q2 we ended at $12.13 million and Q3 we ended at $13.3 million.

We projected for the whole year since Q1 that we were going to be in that 15.5% to 16% range, and we still feel comfortable that we're going to be in that range for the year.

No.

I understand.

I was just trying to figure out is this more -- it's not a huge increase, I agree.

Is it setting the stage for growth initiatives or is it just truing up like we've seen some of the other companies do maybe returning to a 401(k) match or restoring bonus levels or something like that.

I think it's both.

Like I said, for growth and then it's for bringing back 401(k) matches and not having furlough days that we had last year, and things of that nature.

Okay.

Some of the other companies that have reported so far this season have talked about seeing input cost increase.

It's not hard to look at the steel prices going up sequentially and know that's going to be a pressure for some companies.

Are you seeing anything there?

Do you expect more input cost increases and can you talk about pricing right now to recover that as it occurs?

Yes.

We're not seeing much input price increase.

it's spotty here and there, but it's manageable.

Normally we negotiate in our contracts a collar, so that those sorts of things are covered.

I think our major concern this year is going to be the availability of these materials and the lead time on these materials.

And we're expecting to see shortages of these materials and we expect to see shortages of bearings this year.

Right.

What materials specifically do you expect shortages on?

Is it a certain alloy or where is that happening?

Yes.

It's the alloy steels.

It's the alloy stainless steels, and it's some of the carbon steels.

I think there was an article the other day about Timken expanding plant capacity at Faircrest by putting $35 million more in investment in how that mill is booked out for the year.

They're a major supplier of this carbon steel bar.

Is that going to give you an opportunity on the pricing side if some of that comes through, or are there basically collars on your ability to pass costs through to your customers?

Well I think what's going to happen is that, number one, the US manufacturers that consume bearings in their equipment, are not the best planning guys in the whole world, in terms of how they run their MRPs.

And so very often we'll get demand for a bearing very late in the sequence of building out their equipment.

And so we have to respond quickly to make sure that that's available.

It's going to be more difficult to respond to that without the proper print planning and lead time way ahead of the cycle.

And so we're trying to build that in now.

but we're going to do it on a 80/20 basis and 20% of the market is not going to have that planning.

Right.

This is going to be an accelerating year I think in this market if the world doesn't do something stupid.

And finally, fourth quarter typically I think is one of your stronger quarters.

Are there shortages to the point where it would impair your normal sequential revenue growth or is this more of an issue as you look out into the next fiscal year?

No.

We don't see any problem with the fourth quarter.

But it's an issue that we're looking out into next year, and trying to make sure that we understand what the accelerating volume demands are going to be and whether or not we're going to be able to cover that with material.

Got it.

Thanks.

I'll hop back in line.

And, gentlemen, your next question will come from the line of Walt Liptak with Barrington Research.

Please proceed.

Hi.

Thanks.

Good morning.

I just want to ask another one on the SG&A.

if we model in -- we talked about for the gross margin, looks like your SG&A is going to be close to $15 million in the fourth quarter, is that right?

And if it is, why are we seeing that a bump?

Well it isn't.

Big Walt, you know we don't give guidance.

We gave it a range out for the year.

We expect SG&A to come between 15.5% to 16%.

I mean our --

Okay.

You're running on the high end I guess of SG&A to sales?

Well for Q3, given the low volume on -- compared to Q1 and Q2, but on a year-to-date basis we're running at 15.7%.

Okay.

And then the fourth quarter, the tax rate, what tax rate should we use?

35%.

Okay.

And it looks like the operating leverage is coming through at about 30% year-to-date.

Is that a number that you think you can replicate as you go into 2012?

I can't say that we've -- we'll take your 30% as a good number there.

I haven't really looked at it.

Okay.

Maybe we can take that one offline.

Yes.

The industrial sectors you said are starting to moderate a little bit.

I was wondering if you could talk a little bit about which sectors you're seeing the best growth from and which ones are yet to recover.

I guess I'm thinking of some early cycle businesses, like I think you still make some truck bearings that might be recovering, et cetera.

Right.

We're certainly making truck bearings and that sector is strong.

It's a small part of what we do.

But it's still a strong sector and we expect that to strengthen all next year, if the projections are anywhere near close.

I think the mining -- at one point for the mining sector we saw a really super heated demand.

And as a result of everybody turning everything off in early 2009 and then trying to turn it all back on at the end of 2009 and through much of 2010, the demand for the mining sector seems to be more normalized now.

We are seeing pick-ups in the industrial distribution sector in general, and we're seeing good demand in semiconductor equipment.

Okay.

All right.

Thanks for that.

The aerospace business, your commentary was positive about the quotes and multi year contracts that you're looking at.

What growth rate would you think about for the next 12 months?

I think that we probably are talking low to mid-teens on that.

That we ought to take offline, too.

Because I need to research that number a little bit better.

But we've done our planning for next year by sector here and I can -- I'd like to just refresh myself a little bit before we give you a number like that.

Okay.

Okay.

Thanks very much, guys.

And, gentlemen, your next question will come from the line of Fred Buonocore with CJS Securities.

Please proceed.

Hi.

Yes.

Good morning.

Good morning, Fred.

Good morning, Fred.

We've been dancing around the expectations for your fiscal 2012 here, so I'll just address it directly.

Do you think you can grow on the top line somewhere in the vicinity of the top-line growth you're doing this year or can you characterize it as a mid-teens growth or any help you can give us on that would be helpful.

Yes, Fred.

We're expecting to be back to low double digits in total.

That's where we're modeling this.

It could be a little stronger than that depending on what happens on the aircraft cycle and whether or not this 787 ever gets into production.

Sure.

And if we have a particularly strong truck year and we have a particularly strong oil and gas year it could be better than that,but that's what we're looking at right now in terms of internal budgets.

Well, that's helpful.

Thank you.

Then over on the aerospace side, any particular, I guess, segments of the aerospace end market that you're seeing the most growth from?

Is what you're seeing maybe a pick-up on the biz jet side?

Can you get a little more granular for us on that?

Yes.

Well I think a lot of the aircraft after market -- we call it after market, but these are distributors that sell replacement parts for planes, but they also sell to small OEMs that are in the channel to support the builds for Boeing's subcontractors.

So over the past 24, 30 months, there was a depletion of inventory there from everywhere, as a result of basically the push-out and the delay of the 787 program.

And then there was some noodling around with Boeing on -- they had a strike and then they weren't going to increase their production rate of the 737s.

Now they're going to increase the production rate.

So people were unsure of what to do with their inventories, and some of these guys are small.

I think it's hard for them to get financing.

That all seems to have turned around now.

To a man, they're all looking for product because those inventories got a little bit too thin.

So as the big plane build accelerates, these guys, our small customer base there in the after market, moves in position to support that infrastructure and that's what's happening right now.

So it's really large commercial transport related then.

Yes.

We're seeing a little bit of positive noise from the business jet community, but I wouldn't say it's material right now.

Okay.

Then you indicated on the government side you think that has bottomed.

Are we talking specifically the military-type programs and what gives you the sense that demand there has bottomed and I guess presumably will pick back up?

Yes.

Because we know which programs we support and we keep track of the usage rate of our bearings in those programs.

Sure.

And the inventory positions at the government -- in the OEMs for those bearings.

And they were overstocked and now that stock is starting to move into an under stocked position.

So we will see that sector coming back next year.

Great.

Then finally just in terms of the industrial distribution.

Is there any concentration in terms of where your products are going, end markets where your products are going through industrial distribution or is it very widely spread?

It's really dependent upon the economy, and where in the economy there's substantial demand.

If the oil and gas area is booming then our products are being pulled into that region.

If the heavy truck market is booming then our product is probably being pulled into the distributors that service the after market.

When we see the industrial production rate in this 6% range in any given quarter for the US, we know that basically our product is being pulled wherever we have good representation into the US economy.

3.5% is normal steady state.

We don't grow.

We don't shrink.

We just stay even.

But at 6%, we're doubling inventory positions and trying to keep up.

Great.

Thanks very much, guys.

I appreciate it.

And, gentlemen, your next question comes from the line of Samuel Eisner with Sterne, Agee & Leach.

Please proceed.

Good morning, everyone.

Good morning.

Good morning.

I think before, maybe in the third quarter of last year, you gave some goal posts for margins looking out into 2011.

Could you potentially get that for 2012?

I'll ask Dan to answer that one.

Well Sam, I think we're still working on where we think 2012 is going to come out.

But do we think there will be an improvement over this year, our target of 32.5%, yes we do.

But we're not in a position to quantify that now.

All right.

And then looking into the mix, I think you said about 51% this quarter was industrial.

Do you expect that to continue to be the case heading into next year?

Or do you think the mix is going to shift more back to the aerospace and defense side?

That's a good question.

I don't know which horse to bet on there, Sam.

They both right now appear to be very strong.

I think it's going to be 49%, 51% and I don't know who is going to be the stronger.

Okay.

Very good.

And then on the government business.

You said that's basically bottoming right now.

Based on your expertise, you expect the kind of snapback that we saw in industrial, or the recovery there more like the commercial aerospace business, bouncing along and waiting for the distribution side to come back?

No.

Unless we get released on some of the programs that we've been working on for about ten years, we get some good news some day in the mail, I think the bounce back will be just a steady sequential improvement.

Sam?

Hello?

Sam, your line is open.

Sorry about that.

Have you seen on the industrial distribution side any restocking for the distributors or is it still all sell through?

I think it's all sell through.

We don't see any restocking.

We can keep -- we have pretty good visibility to thatand that isn't happening.

Anytime table on that?

For the restocking?

Yes.

No.

I have no timetable.

All right.

Great.

Thank you.

And, gentlemen, your next question will come from the line of Peter Lisnic with Robert W.

Baird.

Please proceed.

Good morning, gentlemen.

I guess first question if you could just clarify a number question for me.

After market up 50% sequentially for aerospace.

Do you have that number on a year-over-year basis?

Yes.

It's about the same.

Okay, so.

Okay.

Implication is OEM is still down.

No.

OEM is -- oh gosh, I wish I had that form in front of me, butI think OEM is up marginally.

Up marginally.

Okay.

All right,and then defense down.

Defense down, right.

Okay.

All right.

Great.

You mentioned the new potential contracts or the wins in the aerospace business.

I'm just wondering if you can give us a sense as to scope or scale.

Then you've gotten a decent amount of questions on SG&A.

I'm just wondering as you pursue some of these programs -- let's ignore FY2011 SG&A, but let's look to 2012 and beyond.

Should we see any incremental spending associated with some of these potential contract wins?

No.

I mean the spending has been taking place all along in the development of the product and expensed through our margins.

So it won't take any more salespeople to accomplish the sale or the [support] of the account.

Those people are in place.

I can only say this, there's just a great deal of uncertainty associated with some of these programs.

We always seem to be at the 11th hour of the day in terms of the approval cycle and we never get to midnight.

But there's nothing that we were working on that's small.

Okay.

And then in terms of the 2012 aerospace outlook that you hinted at, are any of those programs built into that number, I would assume not.

No, they're not.

Okay.

These are more 2013 potentially and beyond, but material in size.

That's the way to think about it, correct?

Yes.

That's right.

Okay.

Perfect.

And then balance sheet obviously getting better and stronger.

What's the acquisition pipeline look like?

And then what's the appetite for doing other things with capital?

Well acquisition pipeline is active.

And we're past due on converting something.

We're working with a few companies that are all in the size range that's historically what we've been doing, that are good fits with our markets and what we know how to manufacture.

So I would think that something positive should happen within the next three to six months.

And can you maybe help us or give us a little bit of color on what seller expectations have been, and then where they're at now?

Have people gotten more aggressive on pricing?

Just what the pricing for deals looks like would be useful.

Yes, the pricing for deals has been extraordinarily high which is why we haven't converted a few of them to this point.

And so we're a little surprised at the fact that some of these are going -- I mean even eight times EBITDA is becoming a floor in some of these -- these investment bankers are doing a great job marketing these things.

So we're seeing conversions at eight plus, some at ten.

Didn't we just see a 15?

I saw a 15.

Yes.

So it's a little shocking.

That's why we like the one that don't have any EBITDA, but have nothing but potential.

Yes.

Understand.

Is that eight, ten or 15 multiples that I'm trailing or forward?

Trailing.

Okay.

That helps me quite a bit.

Thank you very much for your time.

Okay.

And, gentlemen, your next question will come from the line of Edward Marshall with Sidoti & Company.

Please proceed.

Thanks for the follow up.

You talked about sales growth for fiscal 2012 and I think your comments were low level digits.

I'm assuming that is pertaining to volume mostly?

Did you factor pricing in there at all?

Because I got to imagine you talked about shortage of bearings, you talked about the price of steel, putting an upward bias to pricing.

But looking out over the next 12 months, I'm imagining that most of is that is based on volume?

Can you comment on that?

Yes, it's based on volume.

And no, we haven't factored in pricing.

Okay.

So pricing could add some upside side to that number or downside, I guess.

The trends that you're seeing through January, are you trending above plan?

Because you did say you were shocked by aero after market.

You're talking about some pricing movements.

And assuming no slowdown in volume, I've got to imagine some of the stuff that is shocking you, may make you trend slightly above your initial plans.

Any comments there?

Not to put you on the spot.

No, I think that's a good question.

If you roll the clock back to last October, I would have expected to see less growth in aero after market and more growth in aero OEM, and we saw just the opposite.

I didn't expect the government business to fall off as much as it did.

So that's why we went out and made a big study about all of our parts and how many are out there and what the consumption rate is and what the repurchase cycle looks like.

So we got a little bit lucky that the aircraft after market-to-market came back the way it did.

I guess with that said, with production increases going up in the aerospace OEMs over the next two, three years or so, are you concerned at all that OEM hasn't shown a rebound?

And what's the scope of your backlog maybe aero OEM to aerospace after market, that gives you some confidence going forward?

Yes.

The after market probably we don't have much backlog because of the way they buy.

So most of our after market or our backlog would be aerospace and government, and then industrial OEM.

The industrial distributors kind of buy the same way.

What was the second part of your question there?

Were you growing concerned that the aero OEM is trending, I think as you said, below plan or is not as robust as you had thought.

And I'm saying with production increases ahead, I would imagine the supply chains is about to fill up.

Are you concerned that the OEM hasn't recovered yet or do you think that's about to come?

I think that's about to come because the number of new contracts that we're negotiating right now.

The inquiries have been pretty strong?

Yes.

There's a whole contract cycle that we're going through now with a lot of these folks and with bizarre terms and conditions which we're trying to get through.

Excellent.

Thank you.

And gentlemen, your next question will come from the line of Gregory Macosko with Lord Abbett.

Please proceed.

Oh, yes.

Thank you.

Could you just talk a little bit about the military -- or excuse me the after market.

You had very strong growth there.

How did that growth impact the gross margin on a sequential basis?

Good question.

I think the aircraft distribution after market, I think the gross margin there is similar to the aircraft OEM.

Okay.

Okay.

And similarly, relative to the government, is it the same issues as well?

In other words government was less than you expected?

Yes.

Yes.

I think government and aircraft OEM are very comparable, too.

Okay.

And you said you might be feeling -- you say business jet is not material yet.

Yet we've heard comments about that generally speaking.

What is your expectation there, and will you benefit a great deal if that turns?

Yes.

We'll benefit.

I think a lot of that business jet traffic is done through the aircraft after market distributors.

Okay.

We will definitely benefit when we see that turn.

We have our eye on Cessna and Gulf Stream and some of the other producers, Bombardier and Embraer and trying to get a sense of what the turn is looking like.

You hear good things and some not so good things out of Tech Strong relative to Cessna recently.

We see a little life, and then we don't see the kind of life, but we don't see the numbers that we used to see.

I think that market has another 20 months, 24 months to recover.

Okay.

In other words until it begins to recover or until it starts -- or --

No.

Until it gets back to where it was.

Okay.

And then finally with regard to the distributors, both industrial and aero.

It sounded as if inventories in both of those channels are low, albeit in the aerospace sector you said inventories are getting very low.

They are restocking to some point.

Just from your conversations with them, your knowledge of business, do we still have a ways to go before they get back to levels that you believe will be quote "normal" relative to inventories?

Which side, aero --

Both of them.

In other words, it sounds like you said industrial distributors haven't really started to build inventory, I believe you said.

Then the after market and the distributors that sell to the smaller OEMs those inventories got low, but I assume do they still have further to go?

No.

Well, let's start with the industrial distributors.

We don't see any build up of our product in those channels.

Do you expect it, though?

No.

We don't.

They'll just sell through that and there will never be an inventory build within that sector?

Not for us.

Okay.

There may be for other industrial manufacturers, but our products in that channel are often not the primary brand.

Okay.

And then in the after market or that sector?

In the aircraft after market it's the opposite situation.

Our products are probably the primary brand.

And you --

The guys that run that channel they go from too much inventory to too little.

They just go through the normals, US industrial cycle on this thing.

Yes, they'll build out too much and a couple years from now they won't buy anything again.

So there's some inventory build for the next 12 months maybe?

Yes.

Absolutely.

Okay.

Especially if the news is good on the production rates for Boeing.

On Boeing ships.

They'll start to get ahead of that.

If the production rates at Cessna and some of the other airframe builders start to become encouraging, they will definitely work to get ahead of that.

Okay.

Thank you.

And ladies and gentlemen this does conclude the Q&A session.

I would now like it turn the call back over to Dr.

Hartnett for the closing comments.

Well, I would like to thank everybody for participating in the call today and for the Q&A period.

I think there was some good questions there, and we look forward to delivering a good fourth quarter.

I expect everybody kind of knows what that's going to look like now, and look forward to talking to you early next year.

Thank you.

Ladies and gentlemen, we thank you for your participation in today's conference.

This does conclude your presentation and you may now disconnect.

Have a wonderful day.