RBC Bearings Inc (RBC) 2016 Q2 法說會逐字稿

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

At this time, all participants are in a listen-only mode.

Later there will be a question-and-answer session and instructions will follow at that time.

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

I will now like to turn the call over to Michael Cummings, of [Alpha IR Group].

Sir, please begin.

Good morning.

And thank you for joining us for RBC Bearings' fiscal 2016 second-quarter earnings conference call.

With me on the call today are Dr. Michael Jay Hartnett, Chairman, President, and Chief Executive Officer, and Daniel 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's recent filings with the SEC for a more detailed discussion of the risks that could impact the Company's future operating results and financial conditions.

These factors are also described in greater detail in the press release and on the Company's website.

In addition, reconciliation between CapEx and non-GAAP GAAP financial information is included as part of the release and is available on the Company's website.

Now I will turn the call over to Dr. Hartnett.

Thank you, Mike, and good morning.

Net sales for the second quarter of fiscal 2016 were $148.7 million versus $112.6 million for the same period last year.

A 32.1% increase.

Our aerospace markets increased 59.6% on a year-over-year basis and our industrial markets were down 2.4%.

The second quarter of fiscal 2016 sales of industrial products represented 33% of our net sales with aerospace products at 67%.

I would like to take a few minutes and update you on the Sergeant acquisition.

The assimilation of Sergeant business is going well.

Sergeant now account for approximately 30% of our total sales.

And integration is definitely ahead of plan.

We are absolutely delighted to find that some businesses in the group were capacity constrained and we are busy working through the kinks in order to flow product to the customers at the rate that matches demand.

Other area where we focused is procurement.

First, combining Sergeant raw material purchases with those of RBC is yielding the attendant intended and obvious benefits.

Secondly, and even more importantly, Sergeant has a great dependency on external businesses to supply manufacturing services for components that, in many cases, RBC is already tooled to supply.

We are working through these procurements with a make versus buy meter and a plan to convert $5 million per year of these purchases to RBC in sourcing each year over the next few years.

Let's talk a little bit about cost control management.

As you know, RBC formally budgets our businesses every quarter and issues to management a quasi P&L statement daily, showing revenue and daily expenses.

This allows visibility and close control of expenses on a business by business basis, absolutely one of the tools needed to run a variable cost business.

This is all carefully designed around achieving a gross margin objective, something similar to zero-based budgeting.

Sergeant was once a smaller division of a larger company and had not developed this level of spending control since as a result.

This process always produces big benefits whatever we implement it and it is producing benefits for us now at the Sergeant plants.

The Sergeant plants are responding well to RBC production management methods and consequently we expect to see continued margin improvement over successive quarters as we work through the issues.

Sometimes pricing, sometimes methods that underlie the opportunity.

It seems the list of improvement items can last a very long time.

In any event, it appears that, over time, this business can demonstrate margins that are much better than their historical averages.

Relative to our aerospace business, sales were up 59.6% on a year-over-year basis for the quarter.

Aerospace OEM increased 66.8% and aerospace distribution and aftermarket increased 28%.

On an organic basis, including foreign-exchange impact, aerospace distribution and aftermarket increased 2.8% driven by the commercial aircraft aftermarkets.

Aerospace OEMs sales decreased 6%, driven entirely by defense.

Our defense customers contracted as a result of lumpy demand in defense helicopters, which is more a timing issue this year than lost volume.

We plan to see this recover later in the year as a result of where the orders are placed in our annual plan.

Our commercial aerospace OEM was up 1%, driven by the main aircraft builders.

This is another area where demand will accelerate.

Our industrial business was off 12.7% organically.

The component of this drop is constrained plant throughput, as I alluded to earlier, accounting for about a third of the decline.

Another component is lumpiness in the demand for train components.

They were very strong last year.

They are weak this period.

And we expect to see them stronger next year.

This accounts for another third.

And, finally, weak demand from mining and oil markets rounds out the total.

Adjusted gross margin for the second quarter of fiscal 2016 was $56.4 million or 37.9%, compared to $53.5 million or 38.6% for the same period last year.

We are expecting to see sales in the third quarter in the neighborhood of $145 million compared to $106.3 million last year.

Keep in mind this is our shortest quarter in production days due to the holiday season, which has a direct impact on the top line sales of the quarter.

And there is some caution built into this projection as a result of constraints that we talked about earlier.

Our fourth quarter has many more production days based upon the way our accounting calendar is structured and so you really have to look at the two quarters as being representative of that last six months of our business.

I will now turn the call over to Dan, who will provide more details on financial performance.

Thanks, Mike.

SG&A for the second quarter of fiscal 2016 was $24.9 million compared to $18.5 million for the same period last year.

As a percentage of net sales, SG&A was 16.8% for the second quarter of fiscal 2016 compared to 16.5% for the same period last year.

Excluding the impact of Sergeant acquisition of $4.6 million, SG&A year-over-year increased $1.8 million which is mainly due to $0.2 million in stock compensation, personnel related expenses of $1.1 million, $0.3 million in professional fees and $0.2 million in other expenses.

Other operating expenses for the second quarter of fiscal 2016 was expense of $3.6 million compared to expense of $2.9 million for the same period last year.

For the second quarter fiscal 2016 other operating expenses were comprised of $1.1 million in acquisition related cost, $0.2 million in integration and restructuring cost, $2.4 million in amortization of intangibles and this was offset by $0.1 million in

other income.

Operating income was $23.6 million for the second quarter of fiscal 2016, compared to operating income of $18.3 million for the same period in fiscal 2015.

On an adjusted basis, operating income would have been $29.2 million for the second quarter of fiscal 2016 compared to $24.7 million in the same period last year.

Adjusted operating income as a percentage of net sales would have been 19.6% for the second quarter of fiscal 2016, compared to an adjusted 21.9% for the same period last year.

The second-quarter fiscal 2016, the Company reported net income of $14.5 million compared to net income of $13.2 million for the same period of last year.

On an adjusted basis, net income would have been $17.8 million for the second quarter of fiscal 2016 compared to net income of $16.5 million for the same period last year, a growth rate of 8%.

Diluted earnings per share was $0.62 per share for the second quarter of fiscal 2016 compared to $0.57 a share for the same period last year.

On an adjusted basis, diluted earnings per share for the second quarter of fiscal 2016 would have been $0.76 per share compared to an adjusted diluted EPS of $0.70 per share for the same period last year, a growth rate of 8.6%.

Turning to cash flow, the Company generated $18.1 million in cash from operating activities in the second quarter of fiscal 2016 compared to $17.8 million for the same period last year.

Capital expenditures were $4.5 million in the second quarter of fiscal 2016 compared to $8 million for the same period last year.

In the second quarter of fiscal 2016, the Company paid down $20 million on a revolving credit facility, $5.6 million on the term loans and repurchased $5.5 million of Company stock.

The Company ended the second quarter of fiscal 2016 with $44.1 million of cash on the balance sheet.

I will now turn the call back to the operator to begin the Q&A session.

(Operator Instructions) Walter Liptak, Seaport Global.

Mike, I wanted to ask about the commercial OE business.

It looks like excluding or just on an apples to apples basis, it was up 1%.

And I wondered if you could give us some color on -- some of the moving parts might be and getting a low single-digit growth rate like that.

And then you also mentioned that you expected the demand will accelerate.

I wonder what kind of programs you are looking at and what kind of rate of growth would you expect over the next 12 months.

Yes.

Well, the industrial OEM -- is that the business you are referring to?

Oh.

Sorry.

No.

The commercial OEM business.

So the aerospace business that you mentioned was up 1%.

Right.

Right.

Why is that going to accelerate.

Is that the question?

Yes.

I guess that and any color around why we are not seeing better growth last quarter.

Okay.

Sure.

Well, first of all, it would be -- it would have been flat year-to-year on the aerospace so OEM with the exception of where we are going to ship orders to the defense guys.

I mean, we have the orders.

It is just a matter of at what quarter are they coming out so they are going to come out in the last two quarters and they didn't come out in the first two quarters, that sort of thing.

So that brings it flat.

What is going on there, Walt, is Boeing and Airbus are going through major contract negotiations with their sub suppliers in terms of placing new contracts with those suppliers over the next three to five years.

And as a result, there is a lot of moving around in terms of who is going to be the subcontracting supplier to Boeing, who picks up which contract, and who exits which contract.

S

o there is people -- there are other people absorbing new contracts and there is a certain subset that are losing contracts.

Now, those subsystems have our bearings in them.

So the guys that are losing contracts are working down there inventories and the guys that are absorbing the contracts, are starting to ramp up.

And that transition has been occurring here for the last six months.

And, obviously, we have been a part of this, too, because we are negotiating a bunch of contracts with all these folks at the same time.

So what we are seeing is a delay in order placement as the new guys come online.

Some of these guys don't even realize there is bearings in their componentry and we have to make sure they understand not only are there bearings, we are the supplier of those bearings.

And get everything tied together in ink so that is the delay mechanism.

And we are seeing that now break loose and so I think the balance of our year for the aerospace OEM, is going to strengthen every quarter.

Okay.

Well, it sounds like going into the December quarter, you may continue to see some of this delays from the rolloff of some of your subcontractor customers.

Is that true?

You know, I didn't parse it out to what component is -- of the aerospace OEM is going to contribute to that $145 million.

I know that $145 million is sort of mitigated because of some of the constraint problems that we have in the Sergeant plants.

And so, there is some caution in that number to begin with.

Okay.

Got it.

And you made some positive comments on Sergeant, and they are taking to some of your manufacturing methods and focus on gross margin.

I wonder if you can help us understand where those gross margins are right now.

Did you see improvement with Sergeant's gross margins in the quarter?

And maybe what you think you can get those to.

Well, I think, when you look at the Sergeant businesses, there is -- they have some very good businesses and I have some businesses that, overall when we purchased the Company, were not contributors to the overall EBIT number.

So the good businesses, we expect to see those margins expand every quarter.

The businesses that were marginal, we expect to see those margins increase and we are seeing some of those margins increase, but it will be a more -- it will going to be a more gradual increase, number one, based upon some of the existing contracts that they have to execute to.

And, number two, just because of the markets that they are in.

Now, some of our sales -- I don't know if you call that a shortfall to the analyst estimates in our aircraft sales -- was in part the result of price pruning.

And what I mean by that is, when you have a marginal business and you are selling a certain mix and you don't have the skills of the tools to sell that mix, you often sell it at less than the manufacturing cost -- which is not a good thing.

So the way you fix that is you decide which parts you are good at and which parts you are not good at and the parts that you are not good at, you raise prices and, if those parts stay in your mix, then they are profitable.

And if they don't, you really don't miss them.

Because you are not good at making them anyway and they are not material to your business plan.

So we are executing the price-pruning strategy now with some of these marginal businesses and that will continue.

Kristine Liwag, Bank of America Merrill Lynch.

Mike, broadly speaking, as a result of the shuffling of the Boeing subcontractors, do you --?

Are you seeing a net increase or a net decrease in your shipset content?

Good question.

We haven't -- I am just running through -- we haven't seen any significant losses.

We haven't seen any significant losses.

We have seen some hiccups in some of the new products that we have produced.

So I would say we are net positive.

Great.

And the price printing that you just mentioned, is this related to just Sergeant or is this also legacy RBC [Barrick]?

Well, we have always done that with RBC.

You have got to -- when you are in the manufacturing world, you really have to decide what you are good at and where you are going to -- what mix you're going to support with your technology and your capital programs.

And you just can't be everything to everybody.

And so, once you have decided how you're going to build out your revenue base and what is going to be core to that revenue base, and what you need for technology, capital, and human assets, that is part of your -- that is a business plan.

Anything that is sort of outside that core is extraneous and needs to be priced accordingly.

So, is there any way to quantify how much of an impact that would be on topline?

Or is it too early?

And maybe a different way to ask that question would be, what is your expected growth in aero for the second half of fiscal year 2016?

I think those are two different questions.

I think on the Sergeant side of the fence, that will probably have a $5 million per year, maybe a little bit more, impact on revenue.

But that should lead to a substantial improvement in margin.

In our aerospace business, the balance of the year is a number I don't have in front of me right now, Christine.

Great.

And one final question.

In terms of adjusted gross margin, when you first closed the Sergeant deal and we looked at the last 12 months of 2014 pro forma numbers, your adjusted gross margins were more like 36.2%.

But then, now, as we look through the first half of fiscal year 2016, the first quarter was 38.7% and this quarter was 37.9%.

Is there a reason why we shouldn't think that full year 2016 gross margins should be between a 38% or 39% level on an adjusted basis?

Yes.

I think we are in that ballpark.

Just to let you know, to look at it from the six-month standpoint to the second quarter because I am getting Sergeant into the loop here, Class -- you can say [Class RBC] or organic gross margins are at 39.2% over last year 38.7%.

So even though we had a contraction in our business, we were able to still get cost out and maintain and increase those gross margins.

And so -- but, Sergeant, it is a combination, too, as Mike talked about.

They are averaging around 35.8% and -- but some of that is mix and then some of it is contributed, I would say half of it is contributed to the cost savings and improved manufacturing methods in the plants.

(Operator Instructions) Steve Barger, KeyBanc Capital Markets.

For the price proving exercise you mentioned, are any of those noncontributing product lines tied up in long contracts?

Are you able to reprice your exit in pretty short order?

It is both, Steve.

Some of them have long contracts.

Some of them have price open -- even if the contract is long, there is price points that open up in various years where some of the corrections can be made.

And some of the mix corrections can be made.

So that I think by and large it is 80/20, with 80% of it under our control.

Got it.

And I remember the transition for you in the legacy business to making versus buying at a very positive effect on your own results a few years back.

Can you talk about how big the external dollars spend is at Sergeant that you can eliminate and give a little more detail on cadence?

Yes.

Well, the external spend, historically, has been 50% of their sales.

Huge number.

That is a huge number.

It is a number that was one of the magnets that attracted us to the business.

And then, when we saw what the componentry was and how we were tooled, that was very exciting, too.

Now, so I think what we have done is, we have set up an objective here to work with between the Sergeant purchasing and materials management people and the RBC purchasing and materials management people.

A $5 million per year rate of assimilating the Sergeant external purchases into the RBC plants.

So I am assuming with the Sergeant subcontractors make money selling those products to Sergeant and so there has got to be a lot of latent profitability tied up there.

And I would say that the first $5 million is the lowest hanging fruit in each year.

It gets a little bit more difficult.

Based upon mix and based upon how we are tooled.

But we are not seeing any reason why the first two or three years can't be very successful with this program.

Yes.

It sounds like.

Now, is the $5 million number based on capacity issues relative to taking that volume internal?

Do you have to add personnel cost or can you basically just integrate that into production with no step up costs beyond the material?

Yes.

I think we can -- I don't -- I think we just integrated into production.

There might be some personnel ads here and there, but it is not going to be a significant number.

(multiple speakers) It is a major cost absorption equation for us.

So I know you guys are good planners.

The $5 million number, was that based on capacity or just it seemed like it was a reasonable run rate?

And what was the thought process?

Well, the thought process there was to set an objective that could be easily achieved in the first year.

So that these guys got some experience working with the RBC plants, knew which plans were good at what processes.

And so there is a sort of a learning curve here between Sergeant procurement and what they know about RBC.

And so the first year's $5 million was a -- seemed like a reasonable goal that could be readily met.

Understood.

More broadly, from other companies so that this quarter on the industrial side, we have heard about trends for some products continuing to decelerate into October from September.

Are you seeing that in some of your lines or can you talk about where things are relatively better or worse?

For this quarter and maybe into the back half of your fiscal year?

Yes.

I think, if we start out with the business in Switzerland, that business is down and it is down but steady and it is the impact of the currency valuation had when they removed the period between the Swiss franc and that euro last January.

That dampened the demand for our product from our customers who are the Swiss machine tool producers.

So but that demand seems to be at a lower level and very steady.

So we are not expecting anything unusual there and as would be auto is running at 17.8 million, 17.9 million, 18 million cars a year sold in the United States and that is a lot of machine tool component consumption.

So I think in part, that is driven by auto demand so we are feeling okay there.

The mining -- we are looking at our mining numbers and it seems to us that about 80% of our mining business right now is going to the OEM who is supporting his aftermarket.

So I think as long as the mines are working and the copper and the iron is being mined, and the trucks are -- trucks and shovels are being used, that we are expecting the demand to be low there but stable.

And oil and gas, I think oil and gas is pretty low already.

I think the guys that can survive at these levels seem to be surviving.

We really expect oil and gas to come back extremely strong and we are trying to position ourselves in that market to be able to support it properly when that happens.

So just overall, would you expect your industrial business to be -- and I guess this is tough to know because inclusive of Sergeant, but organically, would you be up or down on industrial in second half 2016 versus last year?

I think we're going -- I don't have that comparison with me.

I don't think we're going to be any stronger than we were in the first half.

On a dollar basis.

On a dollar basis.

I am showing no additional questions.

I would now like to turn the call over to Mike Hartnett for closing remarks.

Okay.

Well, in closing, I want to thank everyone for their continued support for RBC Airings and participating in today's discussion and for making RBC Bearings part of your investment strategy.

Thank you very much.

Ladies and gentlemen, this does conclude today's program.

You may all disconnect.

Everybody, have a wonderful day.