RBC Bearings' (ROLL) CEO Michael Hartnett on F1Q 2015 Results - Earnings Call Transcript

Aug.10.14 | About: RBC Bearings (ROLL)

RBC Bearings Incorporated (NASDAQ:ROLL)

F1Q 2015 Earnings Conference Call

August 7, 2014 11:00 ET

Executives

Matt Steinberg - FTI Consulting

Michael Hartnett - Chairman, President, and Chief Executive Officer

Daniel Bergeron - Vice President and Chief Financial Officer

Analysts

Edward Marshall – Sidoti & Company

Walter Liptak – Global Hunter Securities

Steve Barger – KeyBanc Capital Markets

Kristine Liwag – Bank of America Merrill Lynch

Samuel Eisner – Goldman Sachs

Operator

Good day, ladies and gentlemen, and welcome to the Quarter One 2015 RBC Bearings Earnings Conference Call. My name is Matthew, and I will be your operator for today. At this time, all participants are in a listen-only model. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

And now I would like to turn the call over to Mr. Matt Steinberg of FTI Consulting. Please proceed, sir.

Matt Steinberg - FTI Consulting

Good morning and thank you for joining us today for RBC Bearings’ fiscal 2015 first 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 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.

Now, I would like to turn the call over to Dr. Hartnett.

Michael Hartnett - Chairman, President, and Chief Executive Officer

Thank you, Matt and good morning everyone. Net sales for the first quarter of fiscal 2015 were $113 million versus $102.7 million for the same period last year. Our industrial markets increased 19.3% on a year-over-year basis and our aircraft and defense products were up 3.8% over the corresponding quarter. For the first quarter of fiscal 2015, sales of industrial products represented 44% of our net sales, with aerospace and defense products at 56%. Gross margins for the period came in at 38.8% versus 39.4% in fiscal ‘14.

Operating margins were 21.4% for the quarter versus 21.7% for the same period last year. Our first quarter of fiscal 2015 showed the industrial OEM business up about 16.3% and net of acquisitions increased 13.3% over the same period last year.

Relative to industrial distribution in total we saw an increase of 24.7% with an organic growth of 4%. The 4% increase was attributable to steady growth across all of our general industrial markets. The industrial distribution growth in the United States was close to 7.7%. Demand for our products for the industrial OEM markets this quarter was driven by oil and gas producers, mining and construction, and a steady demand of general industrial markets in the U.S. and Europe. We were encouraged to see our European industrial OEM business up 33% and our aircraft business there up a solid 11%.

The good news – the basis formed in the mining market, primarily driven by the industry’s MRO needs, while demand from the general construction sector remains steady. On the industrial side, we are experiencing positive order momentum building across the broad base of industries, which are showing solid growth going into the second quarter. We are expecting to see continued demand from the OEM’s producing equipment for the development and completion of oil and gas fields, heavy trucks, construction, semiconductor equipment, trains, European ground defense vehicles, and machine tools.

Relative to our aerospace and defense business, these markets grew 3.8% in the first quarter of 2015 with a 9% growth in sales to the aircraft OEMs, offset by timing and distribution and steady demand in defense. We continue to see strong demand from our core products, and continued encouragement from our customers to accept and approve new designs, some of which will have a major impact on fiscal years starting 2016. These products were developed for both airframe and engine applications.

Gross margins for the first quarter 2015 was 43.8% – $43.8 million or 38.8% compared to $40.5 million and 39.4% for the same period last year. Our overall gross margin was impacted by new process start-up in industrial products along with a little drag from acquisition accounting. We are happy where the margin story is going, and the continued new process introductions moving to our manufacturing methods programs. We expect to reach our internal goal of adding 70 to 100 basis points by the end of the year.

But as Dan said in the last call, it will be lumpy quarter-to-quarter and back-ended for the year. We did end the first quarter of fiscal 2015 with a $104.5 million in cash and short-term investments after paying $2 per share dividend in June of approximately $46 million. In summary, we ended the first quarter of fiscal 2015 was $120 million in backlog compared to $219 million for the same period last year and $218 million for the fourth quarter of fiscal 2014.

Looking ahead, we expect to see the second quarter of fiscal 2015 net sales to be in the neighborhood of $112 million even with the shortened production days and the summer holiday schedules and shutdowns. This would be a year-over-year growth of about 10%.

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

Daniel Bergeron - Vice President and Chief Financial Officer

Thanks Mike. SG&A for the first quarter fiscal 2015 increased by $2 million to $19 million compared to $17 million for the same period last year. As a percentage of net sales, SG&A was 16.8% for the first quarter fiscal 2015 compared to 16.5% for the same period last year.

The increase in SG&A year-over-year was mainly due to an increase of $0.8 million associated with the addition of two acquisitions, $0.4 million in personnel related expenses, $0.5 million in incentive compensation expense, and $0.3 million in other expenses.

Other net for the first quarter fiscal 2015 was expense of $0.6 million compared to expense of $1.2 million for the same period last year. For the first quarter fiscal 2015, other net consisted mainly of $0.5 million of amortization of intangibles and $0.1 million of other expenses. Operating income was $24.2 million for the first quarter fiscal 2015 compared to operating income of $22.3 million for the same period in fiscal 2014. As a percentage of net sales, operating income was 21.4% for the first quarter of fiscal 2015 compared to 21.7% for the same period last year.

Income tax expense for the first quarter fiscal 2015 was $8.2 million compared to $7.1 million for the same period last year. Our effective income tax rate for the first quarter fiscal 2015 was 34% compared to 32.1% for the same period last year. For the fiscal quarter fiscal 2015, the company reported net income of $16 million compared to net income of $15.1 million for the same period last year. Diluted earnings per share was $0.69 per share for first quarter fiscal 2015 compared to $0.65 per share for the same period last year.

Turning to cash flow, the company generated $26.9 million in cash from operating activities in the first quarter of fiscal 2015 compared to $17.4 million for the same period last year. Capital expenditures were $3.5 million in the first quarter fiscal 2015 compared to $5.8 million for the same period last year and the company, we’re expecting that CapEx range to be in between $14 million to $17 million for this fiscal year. The company ended the first quarter fiscal 2015 with $104.5 million of cash and short-term investments, after paying $2 per share dividend or approximately $46 million on June 30, 2014.

As of the end of the first quarter fiscal 2015 coming at $10.3 million of debt on the balance sheet. I will now turn the call over to the operator for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And that comes from the line of Edward Marshall of Sidoti & Company. Please proceed.

Edward Marshall – Sidoti & Company

Good morning guys.

Michael Hartnett

Good morning.

Edward Marshall – Sidoti & Company

So, you’re not the first aerospace – within your aerospace segment, you’re not the first company we’ve seen this quarter so kind of weaker demand on the aftermarket side, and down about 15% or something. I’m just curious about your opinion. Is there any changes in the distribution channel that is kind of rippling through that – especially when it comes to components, whether it’s fasteners or bearings, as you guys ship? Is there anything that’s changed structurally in the channel? New customers, new way of dealing that you are aware of that might be the cause of this because it seems to kind of buck the trend of what you would think would happen at this portion of the cycle.

Michael Hartnett

I think last year we had a very large quarter for that aftermarket business and so you’re comparing against the difficult comp. When we look at the sort of the run rate over 12 months it’s pretty normal and we see that demand and building again this quarter so, it’s probably just timing. But in terms of structural changes, a lot of these companies now were bought out by PE firms. And they have to service a lot of that. So, there are probably squeezing the working capital more than normal.

Edward Marshall – Sidoti & Company

Okay.

Michael Hartnett

Which is – you can only do that for so long, right?

Edward Marshall – Sidoti & Company

Right, before you’ve got to rebuild that WIP.

Michael Hartnett

Right.

Edward Marshall – Sidoti & Company

I mean, it just seems to buck the trend with the way traffic demand has been across the channel, you would think that the aftermarket would be just – would continue to be strong. When I think about – I’m sorry?

Daniel Bergeron

No, I think Mike’s point was, it is strong still. If you compared the distribution of $12 million in Q1 and there is basically in line of the $12 million in Q4 even with less production date. So, we still see the strength there, but the comp first quarter last year was about 14 – a little over $14 million so, it was just an unusual quarter.

Edward Marshall – Sidoti & Company

Okay. So, is it roughly 19%, 20% of revenues on the aerospace is distribution? Is that would you just said?

Michael Hartnett

I think that’s about right. I’ll just check your math here.

Daniel Bergeron

It’s $12 million on.

Edward Marshall – Sidoti & Company

65, 64?

Daniel Bergeron

$63.5 million.

Edward Marshall – Sidoti & Company

Okay, okay. And then when I think about your gross margin and I know there is a lot of different noise coming through, especially with the acquisitions so forth that you made in the prior year, but as I kind of think about your industrial business building in fiscal 2015, what happens to the margin because I know there is an awful lot of businesses in there that run in the low 20s versus I think mid to high 30s on the aerospace. So I just kind of think about the mix there that would run through on your gross margin that might occur. And I assume there will be some more absorption, but just kind of walk me through on how that might work.

Michael Hartnett

Well, I mean – on the industrial side, there’s – yes, I think the major – the major issue for us on the industrial side is that we see some volume building in products that we – where our capitalization to produce those products was sort of out of step with demand, or becoming out of step with demand. So a lot of those products were processes were outsourced. So over the last 12 to 24 months, we insourced a lot of those processes and now we’re in a kind of a startup mode on those new processes and some of our plans and so, as we mature on the learning curve, the margins there will get better and we see a lot of demand coming for those products in the next 6 to 12 months. So, we’re really working pretty hard to get all of that squared away.

Edward Marshall – Sidoti & Company

And based I guess, Dan, on the CapEx comments, it doesn’t sound like with the insourcing and the additional demand that you see, that there is any reason to really put more capital into the ground, over and beyond, on the industrial side at least.

Daniel Bergeron

It’s normalized now. The capital spent has been put in place and now it’s a matter of start-up, tooling, training, execution, returning to sort of identifying where the – what the Pareto looks like in the problem areas of process and working the Pareto. So that’s right where we are today.

Edward Marshall – Sidoti & Company

Last question, I know there is lot of different lines in your business on both sides of the business. Is there a way to – and I don’t think we normally talk about this, but is there a way to think about utilization rates maybe if you can compile them into aerospace and industrial, and where we are on those two businesses as a whole. Is that possible?

Michael Hartnett

Utilization rate, we use everything. We probably – I think we have right now in the aerospace and the industrial side, we have plenty of capacity to – for the existing products that we produced – to produce 25%, 30% more product without having to put a lot more capital in place.

Edward Marshall – Sidoti & Company

I guess human capital would be the variable there.

Michael Hartnett

It is – it always is.

Edward Marshall – Sidoti & Company

And on the industrial side?

Michael Hartnett

Same. That applies across the company.

Edward Marshall – Sidoti & Company

Across the company, okay. Thanks, guys.

Operator

Thank you for the question. Your next question comes from the line of Walter Liptak of Global Hunter Securities. Please proceed.

Walter Liptak – Global Hunter Securities

Hi, thanks, good morning.

Michael Hartnett

Good morning, Walt.

Daniel Bergeron

Good morning.

Walter Liptak – Global Hunter Securities

Wanted to ask a follow-on to the previous question in aerospace distribution and it sounds like this is a little bit one-timey in the decline. Can you help to give some color on how things trended on a monthly basis through the quarter and any thought on July, August?

Michael Hartnett

Well, August is still pretty young, and July showed some pretty good strength in incoming order rate in total. I can’t tell you that I’ve boiled it down to what came in from aerospace distribution and aerospace OEM, U.S. and Europe, yet. But it looks – it looks more normal. I can tell by the way the plants are booking because certain of these distribution demands hit some plants harder than others in the plants that saw a weak first quarter are now seeing a stronger second quarter. So, that’s probably a good sign of the distribution business is picking up.

Walter Liptak – Global Hunter Securities

Okay, great. When do you negotiate pricing with that distribution channel?

Michael Hartnett

We have multi-year contracts with most of our distributors on most of our products. And I don’t remember what the termination date for those contracts are, but I would guess those are out a couple of years.

Walter Liptak – Global Hunter Securities

Okay, okay. And then kind of unrelated, you talked about the revenue growth for the next quarter being pretty good. I wonder if you can delineate that for us a little bit, by end market or by line of business.

Michael Hartnett

Well, certainly if you start off with the construction and mining side of the business, that’s very strong. Certainly our bookings – our sales in the construction to the mining OEMs that are supporting their aftermarket and we can kind of tell based upon where we get the orders from, what’s going to – what part of the OEM demand is going to new builds, and what part of the OEM demand is going to the aftermarket – that the situation is very strong for the mining aftermarket, stronger than we have head capacity in the first quarter to satisfy so, given the lead times and so on our back orders for the mining market is – are increasing. So, that’s looking very favorable. The industrial distribution business in total looks – continues to look very favorable and strong for us. The aircraft OEM which was up 9% the first quarter, we don’t expect that to be – to change its rate at all whatsoever and so I think the whole gain will be that aerospace distribution fill rate.

Walter Liptak – Global Hunter Securities

Okay. Alright, good. And kind of along those lines, typically your first quarter is a little bit lower gross margin anyways. What are you thinking about for gross margins as you go into the second quarter?

Michael Hartnett

I think Dan has the most recent information on that.

Daniel Bergeron

Okay, I think we’ll be a little better, Walt, than Q1. And like what we had Mike said on his opening comments, probably going to be a little more back-ended for us to get to our internal goal of 70 to 100 bps. We ended last year at 39.3%, so we’re a little behind right now. But we’re still feeling confident that we can achieve that internal goal.

Walter Liptak – Global Hunter Securities

Okay, good. Okay, it sounds good. Thank you.

Operator

Thank you for your question. (Operator Instructions) And the next question comes from the line of Steve Barger of KeyBanc Capital Markets. Please go ahead.

Steve Barger – KeyBanc Capital Markets

Hi, good morning guys.

Michael Hartnett

Good morning.

Daniel Bergeron

Good morning, Steve.

Steve Barger – KeyBanc Capital Markets

You talked about the uptick in the mining market. Does it seem like your customers got surprised by this uptick or were you surprised, I mean, it’s been low for so long. Was this expected or is it coming back quicker than people thought?

Michael Hartnett

Well, I think it’s been low because the industry OEMs were (indiscernible) along with a great build rate, right. So they had all those materials inbound, and all of a sudden business dried up and they still had all those materials inbound. So, it’s – I think the aftermarket is now absorb those materials and what we’re seeing is the true steady state aftermarket demand for MRO replacement and I think it’s always been there. We look at how these mine operators, how many tons of material they mine each month, each quarter, each year, that hasn’t really been affected in a major way. And so the operators are opening the mine; they are operating the equipment. There is a lot more equipment out there than there was in 2008 so, that aftermarket MRO business has been strong all along. I think the inventories have been normalized and what we’re seeing is to demand rate right now.

Steve Barger – KeyBanc Capital Markets

Got you. So, some of that OEM product just shifted to the aftermarket, which caused the inventory channel to lean out. And now you are back to a good supply demand imbalance for those aftermarket parts.

Michael Hartnett

Exactly.

Steve Barger – KeyBanc Capital Markets

Okay. Are you seeing it more, if you can tell for underground or surface or both sides of that equation?

Michael Hartnett

I would – based upon where this is going, its surface.

Steve Barger – KeyBanc Capital Markets

Okay. And do you sell to – well, I guess if you sell to companies that sell internationally, it can go anywhere. But can you tell if it’s more North American-based or more international?

Michael Hartnett

Well, for us, it’s more North American-based just because of our channels are North American strong.

Steve Barger – KeyBanc Capital Markets

Right.

Michael Hartnett

But it’s international than it’s going through the – directly through the OEM channel. And we’re seeing both channels strong.

Steve Barger – KeyBanc Capital Markets

Got you. Has your view on industrial growth being kind of mid-single-digit for the year – I’m sorry, high-single-digit for the year. Has that changed any since you are now one quarter in?

Michael Hartnett

Looks like it’s going to be stronger than we thought – that’s the bottom-line on that. We didn’t expect so much industrial strength this quarter.

Steve Barger – KeyBanc Capital Markets

Well, and I guess similar question on the construction side, are you seeing that across the board for – if you can tell, is it dirt moving, is it aerial equipment, the cranes. Where is the real strength?

Michael Hartnett

Yes, on the construction side, we’re seeing the dirt moving part of construction steady. We’re not seeing any big change and demand there. We’re seeing the aerial lift side of the construction business is strong.

Steve Barger – KeyBanc Capital Markets

Right, okay. Switching gears to the new products for airframe and engine applications, what does that do to your content per aircraft if you got adoption across the board for these products?

Michael Hartnett

It really – it’s substantially increases it. I can’t give you – I don’t have the exact number by engine and which engine is go on the 737 neo or anything like that, or MAX. But we have those numbers and it’s substantial.

Steve Barger – KeyBanc Capital Markets

Got you. I mean, substantial being more than 10%, more than 20%, in terms of content per airframe?

Michael Hartnett

More than 20%.

Steve Barger – KeyBanc Capital Markets

Got you, great. Operating cash flow, Dan, very nice in the quarter. Was that really a function of working cap or what drove that increase?

Daniel Bergeron

Well, little bit of working cap, top-line and that’s basically just a strong quarter, it always is, because we always have a strong fourth quarter, so all that cash is coming in. We can have a big investment in inventory.

Michael Hartnett

And didn’t have a lot of CapEx.

Daniel Bergeron

And we didn’t have a lot of CapEx, from a free cash flow standpoint so…

Steve Barger – KeyBanc Capital Markets

Right. Alright, that’s great. I’ll get back in line. Thanks.

Michael Hartnett

Thank you.

Operator

Thank you. Your next question comes from the line of Kristine Liwag of Bank of America Merrill Lynch. Please go ahead.

Kristine Liwag – Bank of America Merrill Lynch

Hi, good morning.

Michael Hartnett

Good morning, Kris.

Kristine Liwag – Bank of America Merrill Lynch

In aerospace, we are hearing that one of the major distributors is trying to grow its market share by increasing the number of SKUs they offer to customers, but are offering discounts to kind of get those contracts closed. And, in turn, they’ve been saying that they expect to preserve their margins by getting lower product cost from the suppliers. So my question is whether or not you are seeing some of this pricing pressure from them. And I know you mentioned that contracts are generally expected to end in the next couple of years, but is there pressure to renegotiate and are there other items that may be pressuring those margins?

Michael Hartnett

Well, I wonder who you are talking about, Kris. I think they have very big margins over there and mainly in their fastener business. I don’t suspect that they – I think the bearing business is a small part of their total business, a very small part of their total business. So, our contracts extend for several years. I’d have to pull out that one to know exactly what the term date is, but we’re not – as of today, we’re not feeling the kind of pressures that you just explained.

Kristine Liwag – Bank of America Merrill Lynch

Great. Thank you.

Operator

Thank you for your question. The next question comes from the line of Samuel Eisner of Goldman Sachs. Please go ahead.

Samuel Eisner – Goldman Sachs

Yes, good morning everyone.

Michael Hartnett

Good morning.

Samuel Eisner – Goldman Sachs

Just regarding the gross margin pressure this quarter, I was wondering if you could actually parse out how much of the new product spend was embedded into that gross margin.

Daniel Bergeron

$0.01 to $0.02 per share.

Samuel Eisner – Goldman Sachs

That’s very helpful. And then these new products, I mean what is the expected time that they are going to be rolled out? Is this primarily product that you are introducing over on the industrial side? Can you maybe talk about the end market applications for them?

Michael Hartnett

Yes, they are both on the industrial side, and they’re on the aircraft side. The industrial side, they are not new products. They are more new processes for products that are reasonably young lifecycles with us and we expect to see substantial volume increases for those products in the next beginning – almost immediately.

Samuel Eisner – Goldman Sachs

Yes.

Michael Hartnett

So, on the aircraft side, those products are – let’s see, how can I explain that? Those products are associated with new engine introductions by the major engine builders for the more efficient airframes for the MAX and the neo and as the MAX and the neo generate their volumes, then they will absorb our products, which are sort of really key components to those engines and those volumes build a little bit in ’16, more in ’17 substantially more in ’18, mature levels in ’19, ’20, ’21, ’22 and that’s where the really big dollars are.

Samuel Eisner – Goldman Sachs

That’s very helpful. Are you seeing any impact from Partnering for Success at this point?

Michael Hartnett

Well, we’ve been working on it continuously. We have – I think we’ve reached a successful conclusion with that – with Boeing, and that’s where we are today.

Samuel Eisner – Goldman Sachs

Alright. And just going back to the question on cash generation, obviously the last three years, free cash has been less than net income because of the – basically the expansion in CapEx. Are we nearing the point where free cash could begin to equal net income? How do you think about that for the remainder of this year and potentially even into next year?

Michael Hartnett

Yes, I think so I think you go back to our normal run rate of CapEx being around 3% to 3.5% of sales. And I think from a working capital standpoint, we’re not going to see any major investments in working capital over the next 12 to 16 months.

Samuel Eisner – Goldman Sachs

And then just lastly on the gross margin expansion kind of guidepost here of 70 to 100 bps, is that primarily – I guess where does the confidence or conviction come from, is that primarily that new product drag goes away and you should leverage that in the back half of the year, I just wanted to understand that a little bit better.

Michael Hartnett

Well, yes, I think the process drag that we’re going through right now it’s better each quarter and that’s given. So, that $0.01 to $0.02 comes back to us probably by the end of the year gradually.

Daniel Bergeron

The acquisition accounting blends back out and those three acquisitions, the margins every quarter get a little bit better as we transition into RBC’s methods. And then thirdly, we’re getting further and further online with our new polish facility, which will not be a drag and actually we’ll add value by the end of the year to gross margin. So, it’s kind of three items that are impacting the number.

Samuel Eisner – Goldman Sachs

That’s helpful. Thanks.

Operator

Thank you for the question. Your next question comes from the line of Walter Liptak of Global Hunter Securities. Please go ahead.

Walter Liptak – Global Hunter Securities

Hi, thanks for taking my follow-up. I just had a quick one on the revenue growth. If OE is doing well for aerospace and industrial stays strong, it seems to me that the swing factor like you mentioned is aerospace and defense and if that’s coming back in July a little bit, why wouldn't you have greater than 10% or is it just the uncertainty about the aerospace after that distribution?

Michael Hartnett

Well, it’s – no, it’s more associated with lead times now. We’re booking into January, February, March now. So – and basically, our second and third quarter spoken for in terms of rates and programs and promises and demand requirements and all that sort of thing so, it’s really a lead time issue.

Walter Liptak – Global Hunter Securities

Okay. Yes, I get it. Your next quarter production is already baked.

Michael Hartnett

Yes.

Walter Liptak – Global Hunter Securities

Okay, okay, perfect. Thank you.

Operator

Thank you for your questions, ladies and gentlemen. I’ll now like to turn the call over to management for the closing remarks.

Michael Hartnett – Chairman, President, and Chief Executive Officer

Okay, well, I appreciate everybody’s participation in today’s call. Some really good questions. I think we explained our case pretty well, with regard to what to what went on in the quarter. Any additional questions you might have, you can refer to Dan and we’ll happy to try to answer them for you. So, thank you again and we’ll speak once more in October I’m sure.

Operator

Thank you for joining in today’s conference, ladies and gentlemen. This concludes the presentation. You may now disconnect. Good day.

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RBC Bearings (NASDAQ:ROLL): FQ1 EPS of $0.69 misses by $0.01. Revenue of $113M (+10.1% Y/Y) in-line.