RBC Bearings Inc
NYSE:RBC
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Good day, ladies and gentlemen, and welcome to Second Quarter 2019 RBC Bearings Earnings Conference Call. At this time all participants are in listen-only mode. Later will conduct a question-and-answer instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.
I will now like to turn the conference over to your host, Chris Donovan with Alpha IR. You may begin, sir.
Good morning, and thank you for joining us for RBC Bearings fiscal 2019 second quarter earnings conference call. With me on the call today are: Dr. Michael J. Hartnett, Chairman, President and Chief Executive Officer; and Daniel A. Bergeron, Vice President, Chief Financial Officer and Chief Operating 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 on the company's website. In addition, reconciliation between GAAP and non-GAAP financial information is included as part of the release and is available on the company's website.
Now I'll turn the call over to Dr. Hartnett.
Thank you and good morning to all, and welcome. Net sales for our second quarter 2019 were $172.9 million versus the $164.3 million for the same period last year, a 5.2% increase. Excluding the Sargent Canada sales from last year, the organic growth for the quarter was 7.3%. The second fiscal quarter of 2019, sales of industrial products represented 38% of our sales and aerospace products 62%.
Gross margin for the quarter was $67.8 million or 39.2% of net sales. This compares to $61.9 million or 37.7% for the same period last year, a 9.5% increase. Operating income was $35.9 million versus adjusted $31.9 million last year, a 12.4% increase. EBITDA was $47.6 million, a 12% increase over last year. So we're very pleased with the results of the period and are encouraged by the continuing buildup of demand for both our aerospace and industrial products.
Industrial products showed a 7% year-over-year organic sales growth rate. And we continue to see strong overall demand for these products. Industrial OEM was up 5.2% and distribution and aftermarket was up 10.9% on a year-over-year basis. Mining, oil and gas, machine tool and general industrial equipment continued to show continuing strength. In some sites where we are at the limits of our existing capacity, we have expansions planned to support demand for new products both in the mining and the oil and gas markets coming online in the second quarter of our next year.
In the aerospace business, the second quarter net sales were up 7.5% when normalized for the revenues generated last year by Canada. Aerospace and defense OEM was up 8% on an organic basis. Supply chain constraints, internal and external, contract timing and short-term plateau and aircraft build rates driven principally by engine availability continued to hamper the industry.
We have reason to be optimistic. We are getting to the other side of this problem and growth in the double digits in this sector is within sight. In any event, we are busy tooling up several plans for new contracts recently signed with a progressive increase in volumes expected in future quarters driven largely by new products, contracted over the past 12 months and continuing.
Primary aerospace platforms where we will see growth, continue to be 737 MAX, A320, 787, 777x and the Joint Strike Fighter and, of course, the – all of the engine programs that support these airframe, both leap and the gear turbo fan from United Technologies.
Regarding our third quarter, we are expecting sales over the period to be between $174 million and $176 million, compared to $162.7 million last year net of Canada, an increase of between 6.9% to 8.2%. I'll now turn the call over to Dan, for more detail on the financial performance.
Thanks, Mike. SG&A for the second quarter of fiscal 2019 was $29.3 million, compared to $27.6 million for the same period last year. The increase was mainly due to higher personnel cost of $1 million, $0.6 million of additional stock-based compensation and $0.1 million of other items.
As a percentage of net sales, SG&A was 17% for the second quarter of fiscal 2019, compared to 16.8% for the same period last year. Other operating expense for the second quarter of fiscal 2019 was a expense of $2.6 million, compared to expense of $8.9 million for the same period last year.
For the second quarter of fiscal 2019, other operating expenses were comprised mainly of $2.6 million in amortization of intangibles. Other operating expense for the same period last year consisted mainly of $6.5 million related to the restructuring of our Canadian operations and $2.4 million in the amortization of the intangible assets.
Operating income was $35.9 million for the second quarter of fiscal 2019, compared to operating income of $25.4 million for the same period in fiscal 2018. On an adjusted basis, operating income would have been $35.9 million for the second quarter of fiscal 2019, compared to an adjusted operating income of $31.9 million for the second quarter of fiscal 2018.
For the second quarter fiscal 2019 the company recorded an effective tax rate of 11.9%, compared to 36.4% for the same period last year. The reduction in the rate year-over-year was mainly driven by the benefit of the Tax Cuts and Jobs Act and $3.2 million benefit associated with share-based compensation, compared to the $0.4 million benefit per based compensation last year.
For the second quarter of fiscal 2019 the company reported net income of $30.1 million, compared to net income of $14.8 million over the same period last year. On an adjusted basis, net income would have been $30.2 million for the second quarter of fiscal 2019, compared to an adjusted operating income of $20.3 million for the same period last year.
Diluted earnings per share was $1.22 per share for the second quarter of fiscal 2019, compared to $0.61 for the same period last year. On an adjusted basis, diluted earnings per share for the second quarter of fiscal 2019 was $1.22 per share, compared to an adjusted diluted EPS of $0.83 per share for the same period last year.
Turning to cash flow. The company generated $24 million in cash from operating activities in the second quarter of fiscal 2019, compared to $24.2 million for the same period last year. And $57.9 million in cash from operating activities for the six-month period fiscal 2019, compared to $64 million for the same six-month period last year.
Capital expenditures were $10.8 million in the second quarter of fiscal 2019, compared to $7 million for the same period last year. On a six-month basis, CapEx was $17.7 million, compared to $12.7 million for the same six-month period last year.
In the second quarter of fiscal 2019 the company paid down $20.1 million of debt for the six-month period and paid down – sorry, for the quarter and paid down $50.2 million for the six-month period.
Total debt, as of September 29, 2018, was $124.5 million. Cash on hand was $60.4 million.
Now I would like to turn the call back to the operator for Q&A.
Thank you. [Operator Instructions] And our first question comes from George Godfrey from CL King. Your line is now open.
Thank you. Good morning and a very nice job on the quarter, gentlemen.
Thank you.
Dan, you – Dr. Hartnett, you mentioned Aero OEM up 8% but you expect that to go to double digits. What percentage of Aero OEM is the aerospace line item of revenue segment?
Well, George, just hang on a second. So George, in the second quarter, on an organic basis, it was $85.1 million. And total aerospace was $106.5 million.
Got it. Thank you. And then a follow-up question is you did talk about the supply constraints specifically on the engines using up there. But you mentioned some other external factors. What is beyond the engines, is there anything else of significance that is holding up production to go at an even faster rate? Thank you.
Well, as you know, George, the way the industry works, there's a lot of smaller suppliers that provide processes, that are approved by the major engine or airframe OEMs, is sort of the unique supplier of those processes for the industry. And depending upon process, there is only a handful of these people and sometimes fewer than a handful of these people for a given process. Now, by and large, these companies are small and undercapitalized and right now, overwhelmed with demand.
And we need these processes performed on our product in order to complete our product to able to shift those to the customer. And that's, let's say, a common industry problem today and we're one of the people that are incurring that problem. So we're insourcing several of those key processes and have built a plant here in Connecticut, which will be operational in our fourth quarter in a small way and then we'll ramp through the – through its volume through the subsequent next quarters next year.
So that's the issue. It's actually impacted. We could have sold more aerospace products this quarter if we could have gotten through these supply constraints. So where we do see the light at the end of the tunnel and because we didn't – because we built the plant and to make sure that the light was bright and so we're going to go through it and we're confident of that.
Understood. Thank you taking my questions.
Thank you. And our next question comes from Michael Ciarmoli from SunTrust. Your line is now open.
Hey good morning, gentlemen. Nice results and thanks for taking the question. Maybe just to stay on that insourcing. I know you guys have talked about it now for a couple of quarters in a row. Have you had to expand any of those initiatives? I know you’ve thrown out several capabilities. Even, kind of adding qualifications last quarter, but have – has anything incrementally tightened or expanded beyond the scope of what you originally thought was sort of those constraints where you’ve had insource?
No. I mean, it’s – the plant is pretty much stable. We’ve been sourcing equipment and refining processes in our R&D labs to make sure that it’s tuned properly. I’d say the only wrinkle that we had was that nice source for gas explosion in Massachusetts really impacted some of the supply chain. And so that was unexpected and – but we recovered.
Okay. Is it too early in the process to kind of ask what you think the potential margin tailwinds could be once you bring these operations in-house? Or is that – is it more on your end, you’re clearly alleviating bottlenecks but I’ve got to assume that there’s going to be some longer term savings once you get to sort of full run rate or you get over learning curve?
Yes. It’s not only that. It’s a fact that in order to – making these components is a – it’s an economy of scale business and if you lose scale, you really destroy your margins. So when you have an interruption in supply from some of these service providers, you’ll ultimately end up breaking your lot sizes into little pieces so that you could supply the end-user enough product that he can maintain his production lines. And so that’s a place that we don’t want to go and that’s impacting some of our performance today. And so we think we get on the other side of that, we should see some margin expansion in some of our facilities as a result of improved flow.
Got it. And then maybe just the last one for me. Any – we’ve spent a lot of time on Aero OE, any color on the aftermarket? I know that’s still been a pretty attractive side of the business, growing strong. I mean, can you give any color there of trends you’re seeing? Or what maybe growth was in the quarter on the aftermarket side of aerospace?
I think our aftermarket side of the aerospace is unlike the global aftermarket side of aerospace. We supply a handful of distributors that are specialists in the aircraft products and a lot of times, those distributors are really supplying less to the aftermarket and more to the smaller OEMs that are in the supply chain for the engine and airframe builders.
Okay. All right, perfect. Thanks, guys. I’ll jump back in the queue here.
Thank you. And our next question comes from Steve Barger from KeyBanc Capital. Your line is now open.
Hey, good morning guys.
Good morning, Steve.
Sorry, I missed most of the prepared comments. I heard you say in response to another question that Aero OE, I think goes back to double-digit growth. Did you comment on what you’re seeing in demand transfer on the industrial side?
No. We didn’t comment on that but I’ll let Dan comment on that.
Yes. Stephen, in Q2 on the year-over-year basis, the industrials on an organic basis grew at 7%. Industrial distribution was up 10.9% and industrial OEM was up 5.2%. And the order book is still going strong for us and like always, as we always discussed that we think we can grow that business at 2x GDP. And so GDP keeps coming in that 3% to 4% range on growth on the industrial side.
So – oh, that’s good to hear. Obviously, over the past few weeks, the market’s been trading like the cycle’s ending or the tariffs are going to cause demand destruction. The companies that are reporting and those like you seem fairly optimistic, any additional thoughts do you have about what you’re hearing from customers? Whether it’s construction equipment or mining equipment or oil and gas, any specific things you can point to, to let us know how customer settlement feels right now?
On the industrial side, we don’t hear anything negative. We have people that, in some cases who want more product than we’re able to produce. So that’s – we’re addressing that. In terms of the tariffs, it’s hard for us not to like the tariffs given the fact that 25% of all those bearings is coming from China, are 25% more expensive than they used to be. And so that's a big hurdle for some of those suppliers.
Which are some of those industrial end markets that would like more bearings than they can get?
Oil and gas. Construction and mining.
Okay. In the quarter, your incremental margin was the best we've seen in quite a while. Was that mix? Or how did you drive better year-over-year and sequentially margin – incremental margin on a lower revenue growth rate?
Well, you know I don't have it broken down into the pieces, but, you know, taking Canada out of the mix helped us a little bit because their margins were low, which is why we took Canada out of the mix. And secondly, we've had – it's a very favorable pricing environment let’s just put it that way. And thirdly, there's been a lot of investments in plant efficiency and automation and some of those are coming home to roost and so you can see it in each one of our plants. Everybody is just a little bit better than they were last year.
Yes. So we can expect that kind of performance, plus or minus as we go into the back half. Mainly, it seems like there're structural changes, right? Along with pricing?
We don't see any headwinds on margins. It's not obvious, it's more of a mix. There may be some mix calculus there that I'm not thinking of right now but we don't see any headwinds on margins.
Okay. Well, and that's good because margins are at the high end of the historical range over the last six years. Free cash flows running at a solid level, so things are looking good. I know that there have been constraints you added capacity and you expect better absorption but I guess for the new programs that you see out there, do they on a stand-alone basis contribute margin and free cash flow at the same level as the base business right now? Or are you having to take any diluted business as you add that capacity?
No. They are solid citizens.
And our next question comes from Kristine Liwag from Bank of America Merrill Lynch. Your line is now open.
Since your acquisition of Sargent in 2015, you've closed the 10 percentage point in gross margin versus legacy RBC Bearings and you've now delevered the balance sheet. In hindsight, or I guess going forward, how has your success with the Sargent acquisition change, how you think about capital deployment today? Do you have more appetite to acquire more aerospace assets outside of your traditional bearings market and into something more like component manufacturing? I mean with Sargent, you kind of got a bigger hydraulics business than you've historically had and what's your appetite for something larger as well?
Well, we certainly have an appetite for something larger, Kristine. There's no issue there and we look at a lot of businesses each month because there's a lot of very active investment bankers selling us books each month. So we read the books and I think that the – what we're looking for is something that has a common customer base, not so much exactly the components that we make but we certainly like a common customer base because it's a broad population of the Who's Who in the United States and we know these people, we have negotiated terms and conditions with these people and so there's a lot of tight majority being laid and we understand how they behave and they understand us very well. So we look for that common customer base and we look for a strong middle management team. So that's – those are the first third and the third characteristic might be geography. It would be nice if we had a site that's closer to the sites that we already visit each month so that it just didn't make our lives more complicated, but I would say that that's a lower priority on the – in the line-up.
Great. And with your gross margins, I mean you saw sequential 70 basis point margin expansion in the quarter and this is trending a little bit above what you've said that you planned for the full year of about 50 basis points. Does this mean that program starts, the new capabilities are doing better than you thought? Or are you getting better mix? And should we think that the 70 basis points in the quarter should trend for the rest of year or should we see some pressure in the second half?
Well, I think in the second half we don't see any headwinds on margins. So it probably is more mix dependent than anything else. I'd say that overall, the teams that we have at the plant level, are executing very well, probably better than they ever have and they're making good progress on their performance.
So we work with them every day and meet with them every day and meet with them every month and kind of go over what the next priority should be in terms of manufacturing improvement and their execution has been outstanding. So I’m very pleased with it.
Great. Thank you.
Thank you. [Operator Instructions]. And our next question comes from Pete Skibitski from Alembic Global. Your line is now open.
Hey, good morning, guys. Nice execution. There was some concern, I think guys, coming into the quarter about the Hurricane Florence so the impact that it might have had on your South Carolina operations. I think you have three or four facilities there. I think, they’re relatively indolent, but did the facilities there make it through Florence kind of completely unscathed or did it impact results to those units at all during the quarter?
Yes. We expected that Florence would be more of a problem than she was. It didn’t impact the quarter. We did shut one of the plants down completely before Florence made landfall just so that we didn’t get electrical spikes and ruin equipment but it wasn’t a problem as it turned out, Florence went the other way and everybody got a day off.
So just one day, you didn’t lose any revenue from it?
Right.
Okay. Hey, Mike. You’re trying to comment earlier, very interesting but tell me if I’m wrong, my understanding was, most of the China bearing suppliers are largely kind of commoditized suppliers. But your comments, maybe think that maybe that’s not true. Is that not true? Did they actually have some IP that make them competitive in a – if tariffs were an issue?
They are by and large commodity suppliers. We don't see them at the significant IP level but some of the bottom end or our lines are commodity like too and we – right now, we have customers asking us to supply product that we haven't supplied in years. We don't even have the tooling anymore. So it's a buffet of who do you want to do business with and who do you want to supply them
Got it. Interesting. Okay. I guess just one follow-up. Can you talk about how – are you guys back to prior peak revenue yet in mining on oil and gas? I think last year, you were quite a bit off from prior peak levels in those areas. I'm just curious how close you are at this point?
I see, oil and gas were getting pretty close to where we were but we do have new products and new customers who are working with us. So we're hoping we can continue to get some growth on that side of the business and as the volumes continue to go up also at the same time. And on mining, I think we're just getting pretty close but not there yet. And they are also going to introduce some new products into the marketplace and to help continue to give us some nice organic growth on that side of the business.
And last one. Dan, do you have any operating earnings from the reporting segments or is it 10-Q to be out later today, maybe with that info?
Yes. The 10-Q will be on for about three hours.
Okay, great thanks so much guys.
Thank you and I’m showing no further questions at this time. I would now like to turn the call back to Dr. Hartnett for any further remarks.
Okay. Well, I'd like to thank everyone for participating today, and listening to our story at RBC Bearings. And we'll be happy to talk to you again after our third quarter, good day.
Ladies and gentlemen, thank you for your participation in today conference. This concludes today's program. You may all disconnect. Everyone, have a great day.