RBC Bearings Inc (RBC) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter FY14 RBC Bearings' earnings conference call.

My name is Lacy, and I will be your operator for today.

(Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would not like to turn the presentation over to Mr. Michael Cummings, Investor Relations.

Please proceed.

Thank you.

Good morning, and thank you for joining us today for RBC Bearings' FY14 second quarter earnings conference call.

On the call will be Dr. Michael J. Hartnett, Chairman, President, and Chief Executive Officer, and Daniel A. Bergeron, Vice President and Chief Financial Officer.

Before we begin 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 files 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 would like to turn the call over to Dr. Hartnett.

Thank you, Michael, and good morning.

Net sales for the second quarter of 2014, were $102 million, versus $100.4 million last year over the same period.

Our industrial markets were down 12.8% on a year-over-year basis and our aircraft and defense products were up 15.2% over the corresponding quarter last year.

For the second quarter of FY14, sales of industrial products represented 42% of our total sales, while sales of aircraft products represented 58%.

Gross margins for the period came in at a record 39.8%, versus 37.4% in FY13.

Adjusted operating income was 22.4% of sales, compared to 21.1% for the same period last year.

Our second quarter of FY14, showed the industrial business down 12.8%.

Net of the large ground defense program that we had last year, it was a [4.7%] drop.

Sequential quarters tell a different story.

Net of the same ground defense program, we saw an expansion of 4%.

If we remove the contributions from new acquisitions, our industrial business was flat sequentially.

The components of our industrial business are distribution and OEM.

On a year-over-year basis, we are up 17.8% in distribution, and down 13.6% in OEM net of the ground defense program.

Sequentially, we were flat in distribution, and net of the ground defense, up in OEM by 6.2%.

As reported last session, we believe we've seen the bottom of the industrial demand and are now seeing momentum turn slightly in our favor.

Some of our industrial business revenues are lumpy quarter to quarter, and a shift in sales volume from one period to the other happens often and can distort the results.

We experienced some of this shift in the second quarter, and that dampened results slightly for this sector.

Relative to our aircraft and defense business, we definitely saw a pickup in orders as the quarter progressed, for both major aircraft producers.

This is to support an announced increase in the build rates.

We expected the demand to show up earlier in the quarter, and the pickup will be reflected in revenues as early as our fourth quarter of this year.

On further note, I'm proud to report that the quarter, we achieved a Double Gold Status on delivering quality for Boeing, and we were chosen by Embraer as their Supplier of the Year in a category where they have over 400 others competing for this title.

We are very proud of this achievement.

Our third quarter is always our weakest quarter due to the fewer production days and the holiday season.

With that said, we expect our third quarter to look a little better on the top line than our second quarter and up nicely from last year's third quarter in both sales and gross margins.

We saw a positive book-to-bill for both the industrial and aero sectors of our business in the second quarter, so we feel there is momentum building in both businesses.

I'll now turn the call over to Dan, who'll provide more color on the financials.

Thanks, Mike.

I'll jump down to SG&A.

SG&A for the second quarter of FY14, increased by $1.3 million to $17.1 million, compared to $15.8 million for the same period last year.

As percentage of net sales, SG&A was 16.8% for the second quarter of FY14, compared to 15.7% for the same period last year.

The increase in SG&A year over year was mainly due to an increase of $0.4 million associated with the addition of 2 new acquisitions, $0.3 million in personnel-related expenses, $0.2 million in the stock compensation, $0.3 million higher professional fees, and $0.1 million in miscellaneous items.

Other net for the second quarter FY14, was expense of $1.9 million, compared to expense of $0.6 million for the same period last year.

For the second quarter FY14, other net consisted of $0.9 million associated with the large bearing consolidation and restructuring, $0.4 million of amortization of intangibles, $0.4 million of costs associated with completion of acquisitions, and $0.2 million in other expenses.

Operating income was $21.5 million for the second quarter FY14, compared to operating income of $21.2 million for the same period in FY13.

As a percentage of net sales, operating income was 21.1% for the second quarter FY14, compared to 21.1% for the same period last year.

Excluding the costs associated with the consolidation and restructuring of large bearing facilities, acquisition costs, and disposable fixed assets, operating income would have been $22.8 million for the second quarter of FY14, compared to $21.2 million for the same period last year.

Excluding these adjustments, operating income as a percentage of net sales would have been 22.4%, compared to 21.1% for the same period last year.

Income tax expense for the second quarter FY14, was $7.2 million, compared to $4.4 million for the same period last year.

Our effective income tax rate for the second quarter of FY14 was 33.6%, compared to 21.1% for the same period last year.

The effective income tax rates for the second quarters of FY14 and FY13, including $0.2 million and $2.8 million of tax benefit due to the reversal of unrecognized tax benefits associated with the conclusion of federal and state income tax audits.

The effective income tax rate without these discrete items would have been 34.4% for the second quarter of FY14, compared to 34.7% for the same period last year.

For the second quarter FY14, the company reported net income of $14.1 million, compared to net income of $16.5 million for the same period last year.

Excluding the after-tax impact of the restructuring expenses, the acquisition costs, the disposal of fixed assets, the CD SOA payment we received last year, and the discrete tax benefits, net income would have been $14.8 million for the second quarter FY14, an increase of 8.4%, compared to $13.7 million for the same period last year.

Diluted earnings per share was $0.61 per share for the second quarter FY14, compared to $0.73 per share for the same period last year.

Excluding the after-tax impact of restructuring expenses, the acquisition costs, disposable fixed assets, the CD SOA payment last year, and the discrete tax benefits, diluted EPS for the second quarter FY14, would have been $0.64 per share, compared to an adjusted $0.60 per share for the same period last year, an increase of 6.7%.

Turning to cash flow, the company generated $4.2 million in cash from operating activities in the second quarter FY14, compared to $3.2 million for the same period last year.

Capital expenditures were $8.8 million in the second quarter FY14, compared to $5.5 million for the same period last year.

The company ended the second quarter FY14, with $112.3 million of cash and short-term investments, and $10.5 million of debt on the balance sheet.

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

(Operator Instructions) Edward Marshall, Sidoti and Company.

Based on your comments about the acquisition in the industrial business, it sounds like CMP is roughly $25 million annually.

Is that right, from a revenue perspective?

No.

In the last 8 months, we've completed 3 acquisitions, WPA, CMP, and then this in October, TCI.

So all three of them are going to contribute approximately $25 million of revenue, and the purchase price was around $20 million for that $25 million of revenue.

Okay.

The military ground vehicle, is this the last quarter the comps kind of are difficult going forward?

It fell off, I think third quarter of FY13.

There's a little bit in Q3 and Q4, but not of the magnitude that we had in Q2 of last year.

I don't have the exact number in front of me, but it's a lot less.

And then, you've acquired, I guess some significant size business relative to your overall segments, probably like 15% over the last year or so, based on what your comments were.

If I think about kind of what you typically buy, lower margin-type business that you fix up and it takes some time to do that, the margin profile for the core business overall doesn't seem to have been affected at all.

But is there a drag in particular on the industrial business right now as you kind of get those up to, say the RBC standard, if you will, on the margin profile?

And what should we expect for that margin going forward?

Yes, for the next 6 to 9 months, there's definitely going to be some headwind on gross margin and a little bit of headwind on SG&A as we integrate all 3 of these acquisitions into the way we do things.

But $25 million on over $400 million of revenue, it's not a big number.

Right.

But it's definitely a little drag.

Do you care to take a stab at what you might think for FY15's gross margin might look like?

2015?

FY15.

No.

Next fiscal year.

No.

Ed, you know we [don't] give guidance and surely wouldn't be talking about FY15, only being in the second quarter of our FY14.

Yes, I figured as much.

But I figured I'd give it a shot.

Yes.

On the aerospace side, there's been rate increases.

You've kind of telegraphed that for a while, so I assume you're in pretty good shape.

But I just want to ask about capacity.

I know you have some.

But kind of where do you see set up even through the back half of the decade, as it seems there's a pretty good ramp here in some of the aircraft.

Where do you guys stand in capacity?

We're in pretty good shape.

Some of these smaller aircraft businesses that we bought actually give us additional capacity to service the current mix of customers and products that sort of augment their normal business.

And also, as you know, we finished building a plant in South Carolina for the aircraft sector, and the plant in Poland will be directed towards the aircraft sector.

So we're working with the major customers now.

We're studying their supplier base [on] our rate readiness, what they call rate readiness evaluation.

And we get sort of gold stars on that.

And we'll have no trouble keeping up.

And we don't see that we're going to have to add a significant amount of CapEx beyond what we normally experience in order to augment the way we produce these products.

Peter Lisnic, Robert W. Baird.

I guess just to wrap up the acquisition-related question, how much opportunity is there to take cost down in those acquired businesses?

Realizing it's only 25 million bucks of revenue, but there's a, or at least it looks as though there's a margin impact that we're seeing.

How significant can we expect those costs to come down?

Well, I would say over the next 12 to 16 months, we should see some nice leverage on the operating income line from these 3 acquisitions.

Now, CMP, we just did the acquisition in August, right, so --

Yes.

-- TCI, we just closed in October.

So we're just in the beginning stages of that integration.

But WPA, which was a smaller transaction, which we did last March, the gross margin performance on that business is up pretty close to 8 percentage points from the day we bought it.

So it takes a little bit of time, takes 8 months to 16 months to get these guys integrated, to figure out where we have too much cost, where we have to take it out to get the pricing right, and everything else.

So I think FY15 they'll definitely add some benefit to us.

And I think for FY14, to answer Ed's question, at the beginning of the year, the only guidance we gave is that we're going to increase our gross margins at least one percentage point this fiscal year.

And I think we're still, even with these acquisitions, on target to be able to do that and exceed that a little.

on target to be able to do that and exceed that a little.

Okay, yes.

And I'm just trying to get a sense of whether or not these things are running on a combined basis and that, I don't know, pick a number, 25% gross margins versus a [corporate] number that's closer to 38% to 40%, and, thus, you've got some material upside.

But I understand and feel comfortable with your answer, so that's fine.

And then on the industrial business, thanks for the color again on OEM versus distribution and for calling out the military impact.

But I was wondering if you could give us a little bit of insight as to what's going on when you look at industrial outside of construction and mining.

Or maybe talk about those 2 specifically, since they've been identified by customers as being, I guess weak would be the right word of describing it.

Well, we have several different sectors of our industrial business, and construction and mining is one of the sectors that's weak.

I think we're all feeling that it's about as week as it's going to get.

As near as we can determine, most of the product that we're producing today is going into the [spheres] market to support the mining activities, and the mining activities are still strong.

I mean, so there's still operating mines and making their tonnages of copper and iron ore and other things.

But the big producers have cut back their CapEx plans, and so that's affected everybody in the chain.

So we expect the construction and mining business to be stable.

We expect to see some growth in the oil and natural gas business, particularly with what's going on in the offshore rigs and the floating rigs.

And we have targeted our product line in that direction and expect to see some modest expansion next year as we bring some of these new products online.

These are large, complicated designs to execute in the plants.

They're very large bearings.

And so they need a certain approval cycle and a certain test sequence to be with the customer to be assured the product is suitable for its use.

And so we've completed a lot of that, and we're expecting a modestly improved year in the oil and gas sector next year.

On the distribution side of the business, we have enhanced our field sales program, and added additional people to what we consider more productive sectors of the geography, selling the current mix to the industrial distributors.

And so we're seeing good results of that.

I think if you look in our quarter-to-quarter comparisons for industrial distribution, sequentially our US industrial distribution is up and responding nicely to that.

We're seeing some of that industrial distribution softness in Europe, not in the US.

So that part of the program's responding well.

And we have several new product programs under way with some of the major diesel engine manufacturers of components that anti-frictionize engines and makes these engines more robust and suitable for the use.

And with the new CAFE standards driving higher and higher mileage efficiencies for these vehicles, one of the ways these companies achieve those efficiencies is through anti-frictionizing their internal engine components.

And so we have some nice programs there that are starting to produce for us.

So on the industrial side, it's business as usual and a lot of good work being done to expand our offering.

Okay.

That is perfect color on that.

Thank you for that.

And then just last, one quick question on aero.

Any sort of financial or share impact, either positive or negative, from Boeing's partnership for success program that you can give us any insight on?

Hope not.

It's way too early for that right now, Peter.

But clearly, Boeing and the subcontractors are all being aggressively directed to achieve certain savings.

And we are working to understand how to position our product lines relative to those objectives.

And we haven't -- we have a lot of contracts that run out through 2017.

So there's nothing immediate for us, and there's plenty of time to work the efficiency side, the methods side of the business, to maintain or expand your margins, should, in the unlikely event, we have to give up any [pricing].

Understood.

Ron Epstein, Bank of America.

It's actually Kristine Liwag calling in for Ron.

So when we look at your defense business, I guess excluding military vehicles, we heard from some of the helicopter OEMs that orders were down because of the US government shutdown.

Can you kind of talk us through maybe what you're seeing in your order book and maybe how that could affect 3Q sales?

Yes.

It's really not having any effect on our order book.

As a matter of fact, oddly enough, we're seeing some strengthening in Q3 and Q4 sales relative to that market.

And so we're happy with what we see.

I think our mission relative to the defense helicopter business is to expand our offering into those platforms.

And so we have several active programs underway right now in our test labs, qualifying new product that'll go on these ships, because some of these ships are scheduled -- the fleets are enormous and they're scheduled to be used into the 2040 to 2050 time frame.

And it's a very good place for our product to be positioned.

So we're not seeing any dampening whatsoever in demand for that sector relative to previous years.

Great.

And I have a follow-up on kind of the gross margins question.

Your [internal] target has usually been about improvement of 1% per year, and it looks like you're tracking well ahead of that in the first half of the year.

And just to understand, is the second half, I mean, if you're still on track for that, is the second half, are you just being more conservative with M&A or are there other things we should consider?

In terms of the entire year impact, I don't see any degradation in the second half of our gross margins, any material degradation, if any.

It's really hard calculus, given the amount of mix, some of the mix shift, some of the FIFO valuations of inventory and how things are going to roll through.

I mean, sometimes I think it's a mathematical equation that's unsolvable.

But having said that, we don't expect a much, if any deterioration in the gross margin in the second half of the year, and probably could even see a little bump up.

(Operator Instructions) Steve Barger, KeyBanc Capital.

This is actually Tejas filling in for Steve.

Just a couple more on acquisition.

I know that a lot of it's been covered.

But if you were to exclude some of the acquisitions you've done in the quarter, would industrial sales still have been up sequentially?

I think I said yes to that, right?

Let me just check.

There's a lot of moving parts to this thing with all these acquisitions.

But I think industrial sales were flat if I take out the impact of the ground defense, right?

Let me just get to the right spreadsheet here.

Yes, it still would have been up.

I'm just doing the quick math here.

Actually, that's kind of what I was looking for.

I mean, just wanted to make sure it's not just the acquisitions driving the sequential uptick.

And then I guess next, on the margin side, I know you've already talked about year to 16 months or so to fully integrate some of these acquisitions.

Is there any reason why we should think that you wouldn't be able to apply the gross margin efficiencies there as well, the 100 basis points you talk about?

No.

No.

No.

I mean, it's not going to happen in 6 months.

But I think all three of these transactions have the potential to get to our internal targets on gross margin in a 16-month period.

Got it.

And then just stepping away from that, we know everyone's kind of talking about driving productivity.

Are you seeing some of your customers push more engineering-type work your way or getting you involved in the designing process?

Just trying to get a sense of if the margin expansion story has been kind of benefitting from that increased service.

Well, I mean, that's where we live.

We live in the design process.

We are problem solvers for our customers and we are the specialists that they turn to, to design the interface that their machine needs to move, whether it's a jet engine or it's an aircraft or it's a ground military vehicle, or it's a high-speed train, there's a lot of highly engineered components that support the movement one component relative to another.

And when these system designers get to those interfaces, they have to turn to a specialist to solve some of the problems of lubrication and wear and ceiling and stresses and fatigue and material properties, and we're the specialist in that area.

Got it.

So if you were to kind of break that down into buckets, how much would you think is more you bringing that to table versus efficiencies that are reflected here in the margin improvement year over year?

Gosh, I have no idea how to answer that.

Usually when you design, the way it normally works, usually when you design a component for a new system, the first few times that you make that component, you make it in very low (inaudible), because your customer doesn't have the volumes - he's just starting up.

You haven't got the experience making that particular component or you're not tooled right or capitalized right in the plant to make that particular component.

Your methods to manufacture it are first generation.

And by the time --

Sure.

-- (inaudible) [tenth] generation.

So there's a whole maturity learning curve associated with getting the volume up and the learning curve strengthens your margin, and if you work the learning curve and you work the lessens learned, each time you run that production lot, you could substantially improve the way you execute your manufacturing process, and that's where the improvement in margin comes from.

Got it.

No, that makes a lot of sense.

So and just lastly, can you just kind of talk through some of the things you're seeing on the industrial distribution side?

I know a lot of or some of the public distributors have kind of been reporting positive data points.

Just if you could provide some specific to your business there.

Yes.

I mean, we're seeing modest sequential growth in our industrial distribution sector in the US.

We're down a little bit in Europe.

I think we see Europe coming back.

But overall, year to year, we're up substantially.

That's helpful.

Walt Liptak, GHS.

I got on the call a little bit late, so I apologize if this question's been asked.

When I think about your backlog, typically what you report in backlog, the 200-and-plus million is a one-year lookout, right?

And then you've also got a 5-year backlog that's the new products and programs that you've been engineering and getting done that gives you some longer-term visibility.

Is that right?

Yes.

So the question is, as you look out over the next 12 months, are there any larger programs that you can talk about that you're excited about that start coming through to fruition, that can kind of increase the rate of sales or increase the visibility?

Yes, I can think of a few, Walt, but I don't think I want to talk about them.

Can you give me an idea of sector, geographic region, things like that?

Yes.

Well, certainly it's in the -- programs that immediately come to mind are in the aircraft sector, and the region is Asia.

Okay.

That's interesting.

I can't remember that you guys do a whole lot of work out in Asia.

Are these new design wins?

Or what kind of companies are they with?

Well, they're with the normal subcontractors that are supporting the production for Boeing and Airbus.

And they're spread all over the world.

And so we have, over the last, gosh, maybe 3 or 4 years, we have had an initiative going to hire young, bright engineers out of school that have specific language skills relative to support our business in those regions of Asia where people build aircraft.

And so now that we can support the designs and we can support the calls and we can support the customer requirements and talk to these people, business is good.

Sounds great.

Will the production happen at your factories here in the US?

Yes.

I got it.

(Operator Instructions) Samuel Eisner, Goldman Sachs.

So just to finish up on the industrial distribution questions.

The growth that you're seeing on a year-over-year basis, do you think that's purely comp-based or is that aggregate demand actually starting to come through?

And then just a second question on that, is the demand that you're seeing more of a sell-through or a sell-in, as in are distributors starting to restock?

Boy.

Can you ask the first part of that question again?

Yes.

I guess the 18% year-on-year increase in industrial distribution that you're seeing, is that primarily because you just have very, very weak comps that you're able to just actually look very good on or is it pure aggregate demand in your mind?

Well, I mean, we have initiatives here to strengthen that sector substantially.

Those initiatives are taking hold, and some of those include new products in our offering, particularly to the oil and gas markets.

And also, we have sort of taken the industrial distribution market and divided it into its market components, canning and bottling and bricklaying and farming and agriculture and steel making and sort of things like that.

And I've assigned teams to each market segment to profile the users and target the applications of the accounts, and that's producing good results for us.

And then the question on whether it's sell-in or sell-through.

Do you have any sense whether or not distributors are starting to actually rebuild inventories at this point?

Yes.

No, I don't think they're rebuilding inventories.

It's selling through.

Got you.

And then --

If we have any issue with industrial distribution is that they stock so little of our products because the big guys -- we're so much smaller in that sector than the Emersons and the [Escafes] and the Timkens of the world.

Right.

And so when you think about, obviously, you've done a few acquisitions here of late, cash or net cash remains basically flat on a sequential basis.

So just curious how you guys are thinking about capital deployment at this point.

Has your kind of tone changed since you've done these acquisitions?

Are you still active?

Any kind of changes to that mentality at this point?

Well, we talk about that all the time about exactly the appropriate management of that capital.

And we haven't made any conclusions, but we may have some news coming out one of these days.

Thanks very much for that.

And then just on the gross margins, there's been a lot of questions on that.

But you guys are getting pretty close to that 40% level that I believe was a kind of long-term target for you guys.

Any kind of update on how you guys are thinking about the long-term targets for gross margins or are just kind of set in this 100 basis points for 2014, and then we'll look for something else in the future?

Well, I think we like that 40% number.

I think it's a great target.

I hope we have to reset the target.

We drive pretty hard every day to -- I mean, people know what the goals are and how to get there.

And it's, obviously, it's working well right now.

And we haven't had -- the acquisitions that we've made haven't really been significantly dilutive to our gross margin performance.

And it's clear to me that they will accrue quarter-to-quarter improvements in their gross margins because of the solutions that we're bringing to their business problems.

And so I think we're going to do well on that front.

And then just, Dan, on the gross margins, I think that volumes have been, obviously, weaker of late and have been a drag on gross margin.

So just curious if they were still a drag in this quarter and what the expectations are for the rest of the year.

So could you repeat that again?

Yes.

You guys break out in your Q usually, the components of gross profit expansion.

And so just curious if volumes continue to remain a headwind for you guys and you should expect better absorption coming forward.

Just curious how that was this quarter.

Yes.

This quarter it was a little better than last on the aerospace side and a little worse on the industrial side.

So I think, as Mike said, for Q3, we're expecting Q3 sales to be a pinch better than Q2.

So I think we'll be in the same neighborhood on an absorption standpoint and hopefully continue to get additional cost efficiencies and some additional product mix that's impacting the margins [favorably].

At this time, we have no further questions in queue.

I would like to turn the call back over to Michael Hartnett for any closing comments.

Okay.

Well, in closing, I'd like to thank those attending this call today for their continued interest and support of RBC Bearings, and all the RBC people that are listening to this call for their continued excellence they demonstrate in supporting our customers.

Thank you, and good day.

Thank you for your participation in today's conference.

As this concludes your presentation, you may all disconnect.

Good day, everyone.