Michael Cummings - Alpha IR Group Dr. Michael J.

Hartnett - RBC Bearings, Inc. Daniel A.

Bergeron - RBC Bearings, Inc.

Ken H. Newman - KeyBanc Capital Markets, Inc.

Good morning and thank you for joining us for RBC Bearings Fiscal 2017 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 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. 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, Mike, and good morning to all. Net sales for the second quarter of fiscal 2017 were $153.9 million versus $148.7 million for the same period last year, a 3.5% increase.

Our aerospace markets increased 3.2% on a year-over-year basis and our industrial markets increased 4.2%. For the second quarter of fiscal 2017, sales of industrial products represented 33% of our net sales, with aerospace products being at 67%.

Adjusted gross margin for the second quarter fiscal 2017 was $56.7 million or 36.9% of net sales compared to $56.4 million or 37.9% for the same period last year. This rate difference is principally related to mix, which is a timing issue and start-up costs on new programs and some under-absorption of the costs in our oil and gas business.

And the mix timing plays the most dominant role of the three by far. We see margins more reflective of our historical levels in the second half of the year, but we may see some modest headwinds due to new program start-ups both in North America and in Europe.

Adjusted EBITDA for the period was $39.9 million versus $38.5 million last year, a 3.6% improvement. Adjusted EPS for the quarter was $0.78.

In this quarter we saw a consistent contribution to our sales from the Sargent businesses and are seeing year-over-year improvement in operating results in most of the Sargent businesses. We're very much on track here.

Looking at the components of our aerospace and defense business this period, we saw aerospace OEM up 7.5%, off by defense OEM, which was down 1.9%, yielding a positive 6.3% for the OEM component of the sector. Overall the consolidated sector growth was 3.2% net, with the diluting elements being aftermarkets of defense and aircraft.

As mentioned in our previous calls, the later is lumpy quarter-to-quarter and it's mainly driven by Boeing contract placements with their subs, but we are seeing strengthening in the order patterns and distribution market, which is a good sign for the balance of the year. We are very pleased with the results of our five-year demand capacity review we reported last call and completed in October.

The aircraft sector of our business has a very strong outlook for the next three to five year period, showing solid growth in our core business, resulting from new ship build increases or expanded content on ships, including the 737, 787, A350 and the Joint Strike Fighter, as well as new airframe and engine introductions, including the LEAP engine, the A320neo, the A330neo and the 777X. This core business, when augmented by business added through new products recently introduced and now under contract, yields strong account volume for both airframe and engines for the years ahead.

It is clear we will need to make some modest capacity additions at some of our locations to support growth in several of the products that we are contracted to supply. Our projections are now showing a double-digit rate of expansion for RBC products, aircraft products over the next three year window, as a result of these two growth components.

Now, let's turn to the industrial businesses. Overall, they were up 4.2% for the quarter.

We saw strength in market demand for marine products, producers of semiconductor equipment, ground defense, auto and industrial gas turbines and train. We continue to see steady demand from the aftermarket for mining products and machine tool components worldwide.

We expect to see acceleration in demand from the semiconductor, auto and marine products for the years ahead, as new program volumes expand, and momentum here is very good. Weak markets were experienced for heavy truck, industrial distribution, and oil and gas, and the mining OEMs.

The stronger markets are offsetting the weaker ones to show the growth we mentioned. Relative to overall order rates, much of our business is conducted under long-term contracts and of course, there is normal depletion of the order book as the company works its way through some of these contracts.

We are in a good position to renew and expand agreements, and I'm 99% certain we will have good news to discuss in this regard at our next call. No worries here, we are in a very healthy spot.

Regarding our third quarter, this is our seasonally shortest quarter, and our fourth quarter is our seasonally longest period. So please remember that taken together, one normalizes the other.

We are expecting to see sales in the third quarter of fiscal 2017 in the neighborhood of $146 million to $148 million, compared to $144.2 million last year. As you know, this quarter is our shortest, as I mentioned, as a result of holidays and planned shutdowns this year.

It is also affected by some industry noise that extended around delivery delays associated with the geared turbo fan engine. This has a minor impact on both our engine and airframe volumes and we expect much of this to clear in the fourth quarter, which is not encumbered by the holiday schedules, and as I said, is seasonally our strongest.

I'll now turn the call over to Dan, who will give you more information around the financial performance.

Thanks Mike. SG&A for the second quarter of fiscal 2017 was $25.2 million compared to $24.9 million for the same period last year.

As a percentage of net sales, SG&A was 16.4% for the second quarter of fiscal 2017 compared to 16.8% for the same period last year. Other operating expenses for the second quarter of fiscal 2017 was expense $2 million compared to expense of $3.6 million for the same period last year.

For the second quarter fiscal 2017, other operating expenses were comprised mainly of $2.4 million and the amortization of intangible assets offset by income of $0.4 million, and other operating expense for the same period last year mainly consisted of $2.4 million in amortization of intangibles, $1.3 million in acquisition restructuring costs, offset by $0.1 million in other income. Operating income was $29.6 million for the second quarter of fiscal 2017 compared to operating income of $23.6 million for the same period in fiscal 2016.

On an adjusted basis, operating income would have been $29.8 million for the second quarter fiscal 2017 compared to $29.2 million for the same period last year. Adjusted operating income as a percentage of net sales would have been 19.3% for the second quarter of fiscal 2017 compared to 19.6% for the same period last year.

For the second quarter fiscal 2017, the company reported net income of $18.2 million compared to net income of $14.5 million for the same period last year. On an adjusted basis, net income would have been $18.4 million for the second quarter of fiscal 2017 compared to adjusted net income of $17.8 million for the same period last year.

Diluted earnings per share was $0.77 per share for the second quarter fiscal 2017 compared to $0.62 per share for the same period last year. On an adjusted basis, diluted earnings per share for the second quarter fiscal 2017 would have been $0.78 per share compared to adjusted diluted earnings per share of $0.76 for the same period last year.

Turning to cash flow, the company generated $19.3 million in cash from operating activities in the second quarter of fiscal 2017 compared to $18.1 million for the same period last year. Capital expenditures were $4.5 million in the second quarter fiscal 2017, compared to $4.5 million for the same period last year.

In the second quarter of fiscal 2017, the company paid down $14.1 million of debt, and we purchased $0.1 million worth of company stock. And on a six-month basis, the company paid down $34.2 million of debt, and we purchased $3.5 million worth of company stock.

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

Hey. Good morning, guys.

It's Ken Newman on for Steve.

Hi Ken.

Good morning. So, had a quick question.

Regarding the product opportunities you mentioned for OE aerospace, could you talk a little bit about whether that could be a potential fiscal 2018 revenue event, or is that something that's going to be pushed out a little further?

It'll be fiscal 2018. It builds beginning in fiscal 2018, and continues to build all the way through 2020.

Got it. And then, in terms of the significant, or I guess in the CapEx you need to ramp up for these new programs, any color on sizing up how large that ramp could be?

For the CapEx expenditure? Yes, we did the bricks and mortar work a few years ago, so we don't have to do – we have plenty of floor space.

So, it looks like the CapEx will be sort of dedicated and within our normal CapEx rate. It might be a little bit on the high side of the rate.

And obviously, the industrial business is not demanding a lot of CapEx right now, so it's shunted over to these aircraft programs.

Got it. And then, can we just talk about the margin improvement efforts for Sargent?

I know mix was a little bit of an issue, and I understand that those orders can be lumpy. Are you pretty confident, or what is the confidence level in order to achieve the 100 basis points in gross margin expansion for the year?

Company-wide?

Yes.

Well, the – that's still our target. It looks like the mix in the second half of the year improved significantly.

The margin work is sort of improving and ongoing, and we've got a little bit of headwind there, as a result of some of the start-up on these programs. So, we may not – net of that headwind, we may not get to that, quite to that 1% but we'll be in good shape.

Got it. And then I'll just ask one more before getting in line.

Just looking at the quarter earnings releases from some of the other industrial companies that we've listened to this quarter, it seems like a recurring theme, seems to be excess manufacturing capacity and some idle equipment. Obviously, your industrial sales growth has been pretty decent and pretty strong this quarter relative to others.

As you look at the quoting activity for your customers, do you agree with that generalization in the market? And if so, just any thoughts you have on being able to deal with the supply overhang and how long you think it takes to rebalance to that demand?

Well, I think a lot of it depends upon which market you're trying to service and what mix you're servicing it with, and what's the proprietary nature of that mix. And so the markets that are strong for us, we have three green flags with regard to that.

We have good market demand. We have proprietary mix, and so we're in a good shape on the markets that have momentum.

And thank goodness, the markets with momentum are outrunning the markets that don't have the momentum. So net-net, we're ahead of the game.

Thanks gentlemen.

Okay.

Okay. Well, I'm surprised that the call was so short, but I'm also pleased.

So in closing, I'd like to thank everybody for their continued interest and support of RBC and I think we're going to have a very good call in, later in the year. Thank you.

Hi, guys. We were having such a good time, I thought we'd just keep this going.

All right. Just a few clean-up items from me.

I mean, can you talk about, now that we've anniversaried the revenue contribution from Sargent, how should we think about the organic growth in the back half of the year split between industrial and aerospace?

Ken, you know we don't give guidance for the full year. We always just talk about what our expectation is for the next quarter.

So I don't think at this time we're prepared to give guidance for Q4.

Understood. So I guess maybe another way to ask it.

If we look at just third quarter versus last quarter, is most of that demand really coming just from the aerospace side versus the industrial side?

No. I'd say it's about the same ratio.

We haven't run through the calculus on that, but my guess is when you do, it's going to be the same ratio. The industrial might be a tad stronger.

We're seeing some strength there in the industrial side that we didn't see in the second quarter. So, the industrial might be a little bit better, but it's the organic growth really starts to – it's going to be the best for aircraft going forward, not this year but in subsequent years.

And it really starts to show itself in 2018.

Got it. And then in terms of, you mentioned a few of the end markets on industrial that were offsetting some of the weaker ones, I mean, can you give us a little bit of an opinion of where you have the most confidence for the biggest upside for industrial growth as we look into fiscal 2018 or if you look in your backlog?

Yes. Let me just check my notes, what did I say?

Let's see, so what we said was marine products, semiconductor, capital equipment, ground defense, auto and industrial gas turbines and train. Now, what was your question, why are those strong, is that it?

Yes. I mean, if you have confidence level that there's probably some more upside to any one of those markets versus some of the ones that are not performing as well.

Yes. Well, I think marine product is going to do very well for us next year.

It's really hitting its stride and that's one of Sargent's historical offerings. It's been, operationally it just every quarter improves, produces the semiconductor capital.

The semiconductor sector is as you probably know is doing real well if you're with the right partners in that sector. We're definitely with the right partners.

There's a lot of good things happening, a lot of expansions going on, and we just have the right product for the right markets. Ground defense is, it's interesting.

The Department of Defense needs to remanufacture a lot of equipment that's in poor shape today. And so if you look at the defense budgets, you can pretty much see who's getting the contracts, and we're part of a lot of that.

So we're expecting to see some upside for ground defense going forward. Auto is another area that, it's an area that, if you have the right product, the right design, the right processes, you can do reasonably well in that business, provided that you stay away from the commodity side of the street, which we don't like the guys on that side of the street, so we stay off of that area.

But we do have some proprietary products that are well accepted in that industry, and that's an area that we're in the expansion mode right now, so we'll probably do very well on that floor between now and 2020. And train, there's just a lot of things going on in the train world in Europe and in China, and we have a very good position in that regard.

The Europeans are developing inner city trains, sort of high-tech inner city trains. A lot of these trains have various suspension requirements and various connecting requirements, and articulated joints relative to being able to connect them to the electrical grid, and so we have product offerings in all of that area that are being well accepted.

The Chinese are developing high-speed rail by the – I don't even remember the number of kilometers per year that's their goal for installation, but it's a substantial number. I'm sure one quick Google search could get you those numbers.

So there's a lot of hardware being built in China. A lot of that hardware incorporates our products, and so we're busy trying to figure out how to get products to China and how to make more products, and exactly how to do business with them in a larger scale than we do today.

So, that's kind of what's happening on our industrial side.

That's really good color. You mentioned some start-up costs in some new programs this quarter.

Are those mostly behind you now, or is there still some – is the kind of same rate of start-up costs expected in the second half?

No. I think those start-up costs are going to be building modestly, but building quarter-to-quarter going forward for probably the next three quarters.

We have a lot of programs to start up.

Okay. And then you talked about some under-absorption in the O&G business.

Can you provide just a little bit of color with what happened this quarter, as well as what steps you're taking with the strategy for that business?

Sure. Well the oil and gas business is, everybody knows what it's like, right.

I mean there's no secrets there. It's very soft.

The demand for hardware from everybody that's supporting that industry is low. And so, we've kind of backed down our production rates in accordance with that, which sort of leaves an underutilized plan, which is a subset of another plan, but it's still under-utilized.

So the question is, what is the future of the oil and gas business in the United States, and what is the ultimate cost, capital costs and operating costs of a fracked well? Because, certainly the convergence of the economics of the oil business are going to be dictated by the economics of operating and capitalizing a fracked well.

And what does that mean in terms of a per gallon – per barrel rate for the cost of a barrel of oil. And who is, where is that cost level going to settle?

Today, it's artificially low. Where will it be in the future and who is going to be a survivor in that industry?

Can the oil tar sands survive, can the offshore people survive, or it's all going to be fracked wells, land wells? So a lot of decisions have to be made with regard to how to position the company going forward to have the right hardware at the right price for the right market and I can't say that I have all the answers today, but I can say that we're intensely studying our position.

That's fair. Just a couple more from me.

You talked about expansion of double-digit growth in the aircraft products over, I want to say it was for the three to five years. Is it fair to say that that's going to be a bit of a modest piece of growth starting next year and then it starts to compound afterwards, or is that something that you see heavier growth towards the beginning of that program?

I think it builds all through fiscal 2018. I don't know how much we can get into fiscal 2017.

I mean, fiscal 2017 lead time wise is just about over. You have what you have and that's all you can do today, but we have a lot of those programs targeted in fiscal 2018.

And so, that should build out well through that year.

Got it. And then lastly from me, could you just give a little bit of color as to what you're seeing in the distribution channel?

I know it still tends to be lumpy and a little difficult for some of the other suppliers as well. Just any color as to how you look at the visibility in that channel and what you're doing to overcome this lumpiness?

Is it aircraft or industrial?

In aircraft in particular.

Aircraft in particular. The aircraft distribution business, as we participate in it, is really not an aftermarket business.

It's really an OEM business and it's driven by a lot of these people that are supplying parts to the Boeing subcontractors. And so, currently Boeing is very busy trying to get the 777X program launched.

So they have a lot of focus on that and less focus on renewing their contracts with a lot of these subcontractors for their existing business. So I think Boeing is running a little behind on contract placement, and I think that's delaying – that's creating some of the angst in that distribution marketplace.

I think that should clear itself. I mean, sooner or later, they're going to need the hardware for the planes.

They're going to have to put the contracts out, but I think right now they're a little bottled up.

Is that something that should be flushed out before fiscal 2018, or is that something that probably takes a little bit longer?

I don't know how they can wait much longer. I don't know where the fastener people are and all that sort of thing.

Everybody seems to have a little bit different schedule, but there is some, quite a bit of industry delay right now.

Perfect. Thanks for the time, guys.

Thank you.

Well, in closing again, I'd like to thank everyone for their continued interest and support, and we will talk to you again in February.