Good day, ladies and gentlemen, and welcome to RBC Bearings' second quarter 2018 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, this conference call may be recorded. I'll now turn the conference over to Chris Donovan, Office of Investor Relations. You may begin.
Good morning, and thank you for joining us for RBC Bearings' fiscal 2018 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 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.
Hey, thank you, and good morning, and welcome to our conference call here for RBC Bearings. I'll explain the overview of how the quarter went, and then turn it over to Dan for some specific input. Net sales for the second quarter of fiscal 2018 were $164.3 million versus $153.9 million for the same period last year, a 6.7% increase. For the second fiscal quarter of 2018, sales of the industrial products represented 38% of our net sales, with aerospace products at 62%. Gross margin for the second fiscal quarter of 2018 was $61.8 million, or 37.6% of net sales.
This compares to $56.7 million, or 36.9% for the same period last year, a 9% increase. Adjusted operating income was $31.8 million versus $29.8 million last year, a 6.7% increase. As we mentioned last call, we continue to experience startup and low production run costs in several facilities. This is primarily associated with new programs that, when mature, will accrue further benefits to consolidated margins. We expect to see the benefit of this work beginning in the third quarter as good progress has been made to date. Adjusted diluted EPS for the quarter was $0.83 per share. Free cash flow for the quarter was $17.1 million, and corresponding debt was reduced by another $17.9 million.
EBITDA came in at $42.3 million, a 25.8% of revenues. Industrial products showed a 22.9% year-over-year growth rate, and we continue to see strong overall demand for these products. Industrial OEM was up 29.2%, and industrial distribution and aftermarket was up 10.8% on a year-over-year basis. Mining, oil and gas, and semiconductor machinery and semiconductor MRO were the standout markets here. Strength was demonstrated in most of our key markets, which include mining, oil and gas, marine, semiconductor machinery, machine tool, rail, and general industrial distribution. On the aerospace and defense products for this quarter was off about 1.2%. Defense revenues, often lumpy but dependable, were slow during the period, but we expect will accelerate nicely later in the year.
Reduction of build rates for the Boeing 777 program was another headwind. We expect - we expected the planned increases on the 737 MAX, which are ahead, and the 777X introduction next year, which are dialed in and are under contract, to impact this dynamic substantially and positively. Finally, Storm Irma impacted four of our plants over the period. This cost us a few million dollars in sales, as it disrupted not only our operations, but the operations of many of our customers in the region. We worked pretty diligently during September to recover most of the revenues that were that were in jeopardy, but there was still a couple of million dollars left over, and we expect some of that to be recovered in our third quarter.
Regarding our third quarter, we are expecting sales over the period to be between $162 million and $163 million, compared with $146.7 million last year, an increase of somewhere between 10% and 11%. The total year is looking very solid to us today. I'll now turn over the call to Dan for more detail on the financial performance.
Hi, thanks, Mike. SG&A for the second quarter of fiscal 2018 was $27.6 million, compared to $25.2 million for the same period last year. The increase was mainly due to higher personnel costs of $1.9 million, $0.2 million of additional incentive stock compensation, and $0.3 million of other items . As a percentage of net sales.
SG&A was 16.8% for the second quarter of fiscal 2018, compared to 16.4% for the same period last year. Other operating expense for the second quarter of fiscal 2018 was expense of $8.9 million, compared to expense of $2 million for the same year last year. For the second quarter, fiscal 2018, other operating expenses were comprised mainly of $6.5 million related to the restructuring of our Canadian operation and $2.4 million in the amortization of intangible assets. Other operating expense for the same period last year consisted mainly of $2.4 million in the amortization of intangible assets, offset by $0.4 million of other income.
Operating income was $25.3 million for the second quarter of fiscal 2018, compared to operating income of $29.6 million for the same period in fiscal 2017. On an adjusted basis, operating income would have been $31.8 million for the second quarter of fiscal 2018, compared to $29.8 million for the same period last year. Adjusted operating income as a % of net sales would have been 19.3% for the second quarter of fiscal 2018, compared to 19.3% for the same period last year. For the second quarter of fiscal 2018, the company reported net income of $14.8 million, compared to net income of $18.2 million for the same period last year.
On an adjusted basis, net income would have been $20.3 million for the second quarter of fiscal 2018, compared to net income of $18.4 million for the same period last year. Diluted earnings per share was $0.61 per share for the second quarter of fiscal 2018, compared to $0.77 per share for the same period last year. On an adjusted basis, diluted earnings per share for the second quarter of fiscal 2018 was $0.83 per share, compared to an adjusted diluted EPS of $0.78 per share for the same period last year. Turning to cash flow, the company generated $24.2 million in cash from operating activities in the second quarter of fiscal 2018, compared to $19.3 million for the same period last year.
Capital expenditures were $7 million in the second quarter of fiscal 2018, compared to $4.4 million for the same period last year. In the second quarter of fiscal 2018, the company paid down $17.9 million of debt and ended the quarter with $42.9 million in cash. I would now like to turn the call back to the operator to begin the Q&A session.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star and then the one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Peter Skibitski of Drexel Hamilton. Your line is now open.
Hey, good morning, guys.
Good morning, Peter. Morning, Peter.
Hey, maybe Mike, can you talk to us, maybe give us some color on the decision to restructure Montreal? My notes say that this is, I think, a Sargent facility and maybe kind of a build-to-print facility for Pratt Canada. So I'm guessing that maybe, you know, you've got some business unit exposure there, and it looks like maybe they were struggling on margins a bit. But can you maybe confirm some of that and add some color?
Sure. Well, you know, when we did the Sargent acquisition, this business unit was identified during the due diligence period as sort of the least attractive part of the acquisition, and it was certainly a business that was very challenged. And so, you know, after we did the acquisition, there was many barriers to consolidation, and some of those barriers concerned contract obligations that the business had. So we worked through those barriers, and kind of brings us where we are today. And you know, from our view, the business really offered us little in terms of core strategies or synergy.
It required a disproportionate amount of management and capital investment, and we saw really little return for the amount of effort and capital that we'd have to put into the business unit. So, you know, our capital and our efforts are better spent elsewhere, and so we reached the conclusion to liquidate the operation.
Okay. So you're exiting those product lines completely, you're not just moving them to another site?
That's correct.
Okay. And the cash benefit that you mentioned in your release, my, I think my recollection was it's $4.4 million. Is that kind of an annualized fiscal 2019 number?
Yeah, that's what we'll basically generate from the operation through its point of closure at the end of December, and then the liquidation of the balance sheet.
Okay.
You know, minus the cost of shutting it down, obviously.
Right. Okay, okay. And then I just wanted to ask on, on the industrial growth. I mean, I think you guys typically kind of talk about industrial growth at, you know, kind of 2-2.5 x GDP, but you're up, I think, over 15% now in the first half of the year. And I, you know, I didn't think the comps were particularly tough going into the second half, so I'm, I'm just wondering kind of what you think is, is driving this type of double-digit growth. I know the ISM numbers are pretty strong in general, but, you know, there's a sense that this could be a, you know, that the cycle may be even accelerating.
So I'm just wondering what your sense is, if you've got particular OEM areas that have really easy comps, or is this something where maybe you've taken market share? But, you know, it gets to the question of why you're growing so much faster than GDP, I guess.
Well, I think first of all, the GDP is doing a good job all by itself, growing at 3%, even though we had a number of storms shutting down parts of the country for, you know, during the quarter. So maybe that, maybe that GDP growth would have been 4%, who knows? But it's really healthy, and that, you know, when it's healthy like that, our businesses do extremely well as our, as our base and core businesses. So, you know, that's, that's sort of the, sort of the baseline. And I think, you know, you add to that, both oil and gas and mining were extraordinarily depressed for, you know, a number of years.
When oil went from $100 and $110 a barrel to $30 a barrel, basically, they shut the lights off on a good part of the industry. And now everybody knows how to make money at between $50 and $60 a barrel, and all the lights are back on, and all the equipment has to be brought back into production, and a lot of it was cannibalized over the last few years. So you have a disproportionate amount of demand for that equipment right now. And mining kind of follows the same suit. I mean, you know, when the GDP is strong in the United States, you know, the mining sector does well.
Caterpillar and Hitachi and Liebherr and the other people start selling trucks, and everything begins to move again, and that's doing very well, as well.
Okay, okay. And I just thought I'd ask, since it's, you know, with the semiconductor exposure and Apple having the new iPhone launches, do you guys tend to see a pop in your semi business around an iPhone launch?
Yeah, I mean, we'll, you know, we're part of that whole train, so yes. And there's new technology that, you know, went into the iPhone that the industry is tooling for, and that favors us very much.
Okay, okay. So I, I suppose you'd expect that to be stay strong at least for the next couple of quarters, and then maybe at some point next year, you get into a tougher comp on semis. Is that a reasonable logic, would you say, or?
Yeah, I think even beyond that, I mean, we've done a few things internally to help ourselves in terms of market demand and market access, and that's all accruing, you know, positively to us. You know, I think you read, you watch Applied Materials stock and listen to their conference calls, and that's us.
Okay. Okay. Okay, that's great. I'll get back in queue. Thanks, guys.
Yep.
Thank you. Our next question comes from the line of Kristine Liwag of Bank of America Merrill Lynch. Your line is now open.
Hey, good morning, guys.
Morning, Kristine.
I guess I wanted to understand commercial aerospace a little bit better. At what point do you expect to see the significant rate ramp increase in the 737 and A320? And when do you expect to see the benefits of your market share gains on the MAX and the neo? Is there some sort of destocking going on right now in the industry?
No, Kristine, it's actually even stranger than that. You know, if you look at our quarter, first of all, the revenues we lost out of those four plants that were affected by the storm were all. That was all aerospace revenues. So, that was worth a few million dollars. Beyond that, we've had an interesting program started with one of our major aerospace OEMs that we call it the Vanguard program. So we've been chosen by one of our major OEMs as the lead supplier in a new project, which the initiative is based on enhanced production documentation. So, we were just thrilled to be the lead, you know, chosen to be the lead supplier in this new program.
Although we did feel a little bit like Wolf Blitzer being invited to Mar-a-Lago for dinner, but you can't say no to that sort of thing, right? So, that program created some headwinds in one of our major plants, and it delayed some manufacturing for the quarter, as both sides worked out what the definition of production documentation really meant and what each side should do in order to conform to the new definition. So, while that was being done, not enough product was being put through the plant, and so we missed a few million dollars of revenue as a result of it.
Those revenues will catch right back up in the third quarter because all the definitions now agreed upon and, you know, we're sort of back where we need to be and sort of cadillacking along now, trying to recover the lost production. So that was sort of the second element of our quarter. And the third element was, we're not seeing Airbus taking product at the rate of production that they've published to build airplanes in the A300 series, group of planes. So I think they're having trouble getting engines, and I think that they're backing up their plane builds. We track their finished assemblies, and they're down. And so Airbus has a way of catching that up by the end of the year.
I'm sure Pratt is under great pressure to help them catch that up by the end of the year. So that should sort of correct itself over time. So those are really the three factors that impacted the aerospace quarter.
That's helpful. And maybe following up on this Vanguard program. So is this a nonrecurring single event?
Yeah, yeah.
Did you get paid for something like this?
You know, did Wolf have to pay for dinner? I mean, I don't think it's just part of the service that we provide the customer.
I see. That helps a lot. And then maybe following up on gross margins, it seems like for Q3, you'll have catch-up work in aerospace. You've got accelerating growth in industrials. How should we expect gross margins to react in that environment? I mean, it sounds to me like all engines are firing, so you should see significant growth in margins as well.
I keep saying that to Dan, and this is what Dan says. Go ahead, Dan.
You know, Kristine, I think we're still on target to our internal target of trying to get 50-100 basis points by the end of the year. The first quarter, you know, was kind of where we wanted it to be, except for some of these special programs that Mike was talking about that could put a little bit of drag on the year-to-date margin. So we're still shooting to, you know, at least be at the run rate of 100 basis points by the end of the year, and we ended last year at 37.9%, so we're hoping that went in closer to 38.9% on a run rate basis.
That's helpful. And maybe, Dan, a follow-up question for you. With your stock price where it is, and which means, like, the right stock compensation could cost more, should we expect SG&A to be closer to 17% as a percent of sales rather than.
No.
The 16% from before?
I think by the end of the year, we should be lined up pretty much where we were last year, at about 16.7%. We are making some strategic investments in human capital for organic growth, and so that's kind of impacting our numbers on the first half of this year. But we should just start seeing the benefit on the top line from those investments.
Great. Thank you very much, guys.
Thank you, Kristine.
Thank you. And again, ladies and gentlemen, if you have a question at this time, please press Star and then the One key on your touchtone telephone. Our next question comes from Steve Barger of KeyBanc Capital. Your line is now open.
Hi, good morning, guys.
Morning, Steve.
When you get into a typical industrial upturn, do you expect OEM sales to run ahead of distribution the way it did this quarter? Can you talk about where you think inventory levels are for either channel?
Yeah, you know, I think to some extent this quarter, some of the industrial distribution sales, you know, we had some big OEM programs that started through industrial distribution and then converted over to direct OEM programs. So, the distribution number is a little bit lower than it should be, or should have got some more credit for the distribution number than we got. Yeah, I think you normally see in an uptick like this, you normally see the OEMs building out first, leading the uptick, and then the distributors coming back with a little bit lower numbers, but better numbers. I think that's just typical of this industry.
This isn't really too anomalous from what you would have expected?
No, it's not.
Do you have any sense for, you know, you said some of the projects converted from distribution to OEM? Is that just because they needed that product faster and didn't want to deal with the channel? And you know, going back to the inventory levels, is that indicative of low inventory at OEMs?
Well, it's first of all, the OEM, you know, decides how he wants to buy the product. We can't decide that for him. And obviously, if he buys through distribution, there's got to be a markup for the distributor. And so when these programs get into production, it's not uncommon for them to come directly to the manufacturer when they're large programs. And that's in part what happened there. So that's the first answer to your question.
And relative to the distribution inventories, I mean, we're still looking at that, but I would think that, you know, based upon the way they're buying, and they have really good systems, so they, you know, they watch their turns and their inventory turns and all that sort of thing very closely. So, I would expect that they're running pretty lean, and I would think that they wouldn't be buying at these rates if they weren't running this lean.
Right. Material cost increases, you know, as things look like they're picking up fairly well. Are you starting to see any on your end? And are you taking price actions to offset that?
Well, obviously, there's price actions wherever we can take price actions. And, we're not seeing major material increases, but our, you know, much of our core materials are under long-term contracts with agreed-to pricing. So we've got a certain baseline already set. And then the materials that we consume that are under long-term contract price would be for sort of the, you know, the 20% of the material spend, where we have a tremendous amount of variation. That's where we might have some exposure. We haven't seen much of that lately in terms of increases, but our antennas are way up on it.
Yeah. Well, and I guess to that point, are there any input availability issues? And how do you feel about your own capacity, given the ramp you're seeing?
Well, that's occasionally that worries us. You know, we were getting pretty close to having demand beyond our capacities, and we don't like that. But and I think that surge sort of normalized over the last quarter to something that's you know, more digestible for us. But we're busy. I mean, the industrial side of the business is very busy.
Well, and I had to hop off the call for a minute, but did you talk about how trends were in October? Or did you, I mean, you kind of alluded to it, but you're seeing a continuation of the ramp?
Oh, yeah. Yeah. Yeah, the year looks very solid from, you know, in both sectors, industrial and aerospace.
Last question from me. You've always been very systematic in your approach toward gross margin expansion. Can you talk through any specific things on the punch list where you're focused right now to either drive that expansion or to improve capacity via efficiency?
Yeah, well, you know, right now, we're really focused on these startup programs, where we're bringing on, you know, major contracts with major revenues, and we're early in the, you know, we're early in the number of units per quarter produced stage on some of these. And so, you know, a lot of our engineering effort is going into these startups and getting the margins where the margins need to be on these products. So, you know, you don't start them up. They're not pretty when you start them up. They're actually pretty ugly when you start them up. And so you've got to work pretty hard on learning curve and manufacturing strategy and manufacturing execution in order to get ahead of that curve.
I'm pretty happy with where we are on most of these programs relative to that curve.
Understood. Well, I guess in terms of normal course of business, are you investing in automation? Are you doing any internal capacity expansions for existing programs to, you know, drive more capacity?
Yes. Well, we are using a lot of robotics.
That's, that's newer? I haven't been to a facility for a while, but I, I don't recall that there was a lot of robotics before.
Well, you ought to get out more. Yeah, it's in the last 24 months, I would say, that, you know, you don't do anything like that overnight. There's just a heck of a lot of technical barriers to getting it operational and effective, and problems that have to be solved. And so we have a lot of work, people working on that stuff, and I'm absolutely thrilled at the progress we're making. I mean, I get chills down my spine when I see the progress we're making.
Well, it's good to hear, Mike. Thanks for the time.
Okay. Thank you, Steve.
Thank you, and I'm showing no further questions at this time. I'd like to hand the call back to Dr. Hartnett for any closing remarks.
Okay. Well, I thank everybody for participating in the call today, and we look forward to speaking to you again and executing an outstanding third quarter. Thank you very much.
Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. We all disconnect. Everyone, have a great day.