RBC Bearings INC - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 28, 2019

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .

Commission File Number: 333-124824

RBC BEARINGS INCORPORATED
(Exact name of registrant as specified in its charter)

(203) 267-7001
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of October 25, 2019, RBC Bearings Incorporated had 25,019,989 shares of Common Stock outstanding.

TABLE OF CONTENTS

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

RBC Bearings Incorporated

Consolidated Balance Sheets

(dollars in thousands, except share and per share data)

See accompanying notes.

RBC Bearings Incorporated

Consolidated Statements of Operations

(dollars in thousands, except share and per share data)

(Unaudited)

See accompanying notes.

RBC Bearings Incorporated

Consolidated Statements of Comprehensive Income

(dollars in thousands)

(Unaudited)

See accompanying notes.

RBC Bearings Incorporated

Consolidated Statements of Stockholders’ Equity

(dollars in thousands)

(Unaudited)

 Common Stock

Additional Paid-In Capital

Accumulated Other Comprehensive Income/(Loss)

Retained Earnings

Treasury Stock

See accompanying notes.

RBC Bearings Incorporated

Consolidated Statements of Stockholders’ Equity (continued)

(dollars in thousands)

(Unaudited)

See accompanying notes.

RBC Bearings Incorporated

Consolidated Statements of Cash Flows

(dollars in thousands)

(Unaudited)

See accompanying notes.

RBC Bearings Incorporated

Notes to Unaudited Interim Consolidated Financial Statements

(dollars in thousands, except share and per share data)

1. Basis of Presentation

The interim consolidated financial statements included herein have been prepared by RBC Bearings Incorporated, a Delaware corporation (collectively with its subsidiaries, the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. The interim financial statements included with this report have been prepared on a consistent basis with the Company’s audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 30, 2019. We condensed or omitted certain information and footnote disclosures normally included in our annual audited financial statements, which we prepared in accordance with U.S. Generally Accepted Accounting Principles (U.S. GAAP). As used in this report, the terms “we”, “us”, “our”, “RBC”, “RBCA” and the “Company” mean RBC Bearings Incorporated and its subsidiaries, unless the context indicates another meaning.

These statements reflect all adjustments, accruals and estimates consisting only of items of a normal recurring nature, which are, in the opinion of management, necessary for the fair presentation of the consolidated financial condition and consolidated results of operations for the interim periods presented. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Annual Report on Form 10-K.

The results of operations for the three and six-month periods ended September 28, 2019 are not necessarily indicative of the operating results for the entire fiscal year ending March 28, 2020. The three-month periods ended September 28, 2019 and September 29, 2018 each include 13 weeks. The amounts shown are in thousands, unless otherwise indicated.

2. Significant Accounting Policies

 Accounting Policies [Textual]

The Company’s significant accounting policies are detailed in “Note 2 - Summary of Significant Accounting Policies” of our Annual Report on Form 10-K for the year ended March 30, 2019. Significant changes to our accounting policies as a result of adopting new accounting standards are discussed below.

Recent Accounting Standards Adopted

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842). The core principle of this ASU is that an entity should recognize on its balance sheet assets and liabilities arising from a lease. In accordance with that principle, ASU 2016-02 requires that a lessee recognize a liability to make lease payments (the lease liability) and a lease asset (right-of-use asset) representing its right to use the underlying leased asset for the lease term. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee will depend on the lease classification as a finance or operating lease.

The Company adopted this accounting standard on March 31, 2019 and has elected the modified retrospective transition method which permits the application of the new lease standard at the adoption date and recognition of a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company has elected not to apply the recognition requirements to short-term leases, and will recognize the lease payments in the income statement on a straight-line basis over the lease term and variable payments in the period in which the obligation for those payments is incurred. The Company has elected the following practical expedients (which must be elected as a package and applied consistently to all leases): an entity need not reassess whether any expired or existing contracts are or contain leases; an entity need not reassess the lease classification for any expired or existing leases; and an entity need not reassess initial direct costs for any existing leases. The Company has also elected the practical expedient which permits the inclusion of lease and nonlease components as a single component and account for it as a lease. This election has been made for all asset classes. We also elected the hindsight practical expedient to determine the reasonably certain lease term for existing leases which resulted in the extension of lease terms for certain existing leases.

The cumulative-effect of the changes made to the balance sheet on the first day of adoption resulted in the recognition of lease assets and lease liabilities for operating lease commitments of $27,378. The adoption of this accounting standard had no impact on the Company’s consolidated statement of operations, debt compliance or the captions on the consolidated statement of cash flows.

The Company determines if an arrangement is a lease at contract inception. For leases where the Company is the lessee, it recognizes lease assets and related lease liabilities at the lease commencement date based on the present value of lease payments over the lease term. The lease term is the noncancellable period for which a lessee has the right to use an underlying asset, including periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option and periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option. For renewal options, the Company performs an assessment at commencement if it is reasonably likely to exercise the option. The assessment is based on the Company’s intentions, past practices, estimates and factors that create an economic incentive for the Company. Generally, the Company is not reasonably certain to exercise the renewal option in a lease contract, with the exception of some of our leased manufacturing facilities. While some of the Company’s leases include options allowing early termination of the lease, the Company historically has not terminated its lease agreements early unless there is an economic, financial or business reason to do so; therefore, the Company does not typically consider the termination option in its lease term at commencement.

Most of the Company’s leases do not provide an implicit interest rate. As a result, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments.

Lease expense for operating leases is recognized on a straight-line basis over the lease term as an operating expense while the expense for finance leases is recognized as depreciation expense and interest expense using the accelerated interest method of recognition.

In February 2018, the FASB issued ASU No. 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income which allows companies to reclassify stranded tax effects resulting from the TCJA from accumulated other comprehensive income to retained earnings. These stranded tax effects refer to the tax amounts included in accumulated other comprehensive income at the previous 35% U.S. corporate statutory federal tax rate, for which the related deferred tax asset or liability was remeasured to the new 21% U.S. corporate statutory federal tax rate in the period of the TCJA’s enactment. The new standard is effective for fiscal years beginning after December 15, 2018, with early adoption permitted, and can be applied either in the period of adoption or retrospectively to each period impacted by the TCJA. As a result of the Company’s adoption on March 31, 2019, the Company reclassified $1,289 from accumulated other comprehensive income to retained earnings, both of which are components of total stockholders’ equity. The adoption of this accounting standard had no impact on the Company’s consolidated statement of operations, debt compliance or the captions on the consolidated statement of cash flows.

Recent Accounting Standards Yet to Be Adopted

In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The objective of this standard update is to simplify the subsequent measurement of goodwill, eliminating Step 2 from the goodwill impairment test. Under this ASU, an entity should perform its annual goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, assuming the loss recognized does not exceed the total amount of goodwill for the reporting unit. The standard update is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

In September 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The new guidance will replace the current incurred loss approach with an expected loss model. The new expected credit loss impairment model will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt instruments, net investments in leases, loan commitments and standby letters of credit. Upon initial recognition of the exposure, the expected credit loss model requires entities to estimate the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses should consider historical information, current information and reasonable and supportable forecasts, including estimates of prepayments. Financial instruments with similar risk characteristics should be grouped together when estimating expected credit losses. ASU 2016-13 does not prescribe a specific method to make the estimate, so its application will require significant judgment. This ASU is effective for public companies in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the effect that the adoption of this ASU will have on the Company’s consolidated financial statements.

Other new pronouncements issued but not effective until after March 28, 2020 are not expected to have a material impact on our financial position, results of operations or liquidity.

3. Revenue from Contracts with Customers

Disaggregation of Revenue

The Company operates in four business segments with similar economic characteristics, including nature of the products and production processes, distribution patterns and classes of customers. Revenue is disaggregated within these business segments by our two principal end markets: aerospace and industrial. Comparative information of the Company’s overall revenues for the three and six-month periods ended September 28, 2019 and September 29, 2018 are as follows:

Principal End Markets

Remaining Performance Obligations

Remaining performance obligations represent the transaction price of orders meeting the definition of a contract in the new revenue standard for which work has not been performed or has been partially performed and excludes unexercised contract options. The duration of the majority of our contracts, as defined by ASC 606, is less than one year. The Company has elected to apply the practical expedient which allows companies to exclude remaining performance obligations with an original expected duration of one year or less. Performance obligations having a duration of more than one year are concentrated in contracts for certain products and services provided to the U.S. government or its contractors. The aggregate amount of the transaction price allocated to remaining performance obligations for such contracts with a duration of more than one year was approximately $259,181 at September 28, 2019. The Company expects to recognize revenue on approximately 70% and 94% of the remaining performance obligations over the next 12 and 24 months, respectively, with the remainder recognized thereafter.

Contract Balances

The timing of revenue recognition, invoicing and cash collections affects accounts receivable, unbilled receivables (contract assets) and customer advances and deposits (contract liabilities) on the consolidated balance sheets.

Contract Assets (Unbilled Receivables) - Pursuant to the over-time revenue recognition model, revenue may be recognized prior to the customer being invoiced. An unbilled receivable is recorded to reflect revenue that is recognized when (1) the cost-to-cost method is applied and (2) such revenue exceeds the amount invoiced to the customer.

Contract Liabilities (Deferred Revenue) - The Company may receive a customer advance or deposit, or have an unconditional right to receive a customer advance, prior to revenue being recognized. Since the performance obligations related to such advances may not have been satisfied, a contract liability is established. Advance payments are not considered a significant financing component as the timing of the transfer of the related goods or services is at the discretion of the customer.

These assets and liabilities are reported on the consolidated balance sheets on an individual contract basis at the end of each reporting period. As of September 28, 2019 and March 30, 2019, accounts receivable with customers, net, were $129,618 and $130,735, respectively. The tables below represent a roll-forward of contract assets and contract liabilities for the six-month period ended September 28, 2019:

As of September 28, 2019, the Company did not have any contract assets classified as noncurrent on the consolidated balance sheets.

4. Accumulated Other Comprehensive Income (Loss)

The components of comprehensive income (loss) that relate to the Company are net income, foreign currency translation adjustments and pension plan and postretirement benefits.

The following summarizes the activity within each component of accumulated other comprehensive income (loss), net of taxes:

5. Net Income Per Common Share

Basic net income per common share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding.

Diluted net income per common share is computed by dividing net income by the sum of the weighted-average number of common shares and dilutive common share equivalents then outstanding using the treasury stock method. Common share equivalents consist of the incremental common shares issuable upon the exercise of stock options.

The table below reflects the calculation of weighted-average shares outstanding for each period presented as well as the computation of basic and diluted net income per common share:

At September 28, 2019, 209,040 employee stock options and no restricted shares have been excluded from the calculation of diluted earnings per share. At September 29, 2018, 212,835 employee stock options and no restricted shares have been excluded from the calculation of diluted earnings per share. The inclusion of these employee stock options and restricted shares would be anti-dilutive.

6. Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

Short-term investments, if any, are comprised of equity securities and are measured at fair value by using quoted prices in active markets and are classified as Level 1 of the valuation hierarchy.

7. Inventory

Inventories are stated at the lower of cost or net realizable value, using the first-in, first-out method, and are summarized below:

8. Goodwill and Intangible Assets

Goodwill

⁽¹⁾ Includes the assets acquired as part of the Company's acquisition of Vianel Holding AG (“Swiss Tool”) on August 15, 2019, which is discussed further in Note 13.

Intangible Assets

⁽²⁾ Includes the assets acquired as part of the Company’s acquisition of Vianel Holding AG (“Swiss Tool”) on August 15, 2019, which is discussed further in Note 13.

Amortization expense for definite-lived intangible assets for the three and six-month periods ended September 28, 2019 were $2,309 and $4,593, respectively, compared to $2,568 and $4,931 for the three and six-month periods ended September 29, 2018, respectively. Estimated amortization expense for the remaining six months of fiscal 2020, the five succeeding fiscal years and thereafter is as follows:

9.  Leases

The Company enters into operating leases for manufacturing facilities, warehouses, sales offices, information technology equipment, plant equipment, vehicles and certain other equipment with varying end dates from October 2019 to February 2038, including renewal options.

The following table represents the impact of leasing on the consolidated balance sheet:

The Company did not have any finance leases as of September 28, 2019. Cash paid included in the measurement of lease liabilities was $1,368 and $2,731 for the three and six-month periods ended September 28, 2019, respectively. Lease assets obtained in exchange for new operating lease liabilities were $3,191 and $3,369 for the three and six-month periods ended September 28, 2019, respectively.

Operating lease expense was $1,651 and $3,488 for the three and six-month periods ended September 28, 2019, respectively. Short-term and variable lease expense were immaterial for both the three and six-month periods ended September 28, 2019.

Future undiscounted lease payments for the remaining lease terms as of September 28, 2019, including renewal options reasonably certain of being exercised, are as follows:

The weighted-average remaining lease term on September 28, 2019 for our operating leases is 11.5 years. The weighted-average discount rate on September 28, 2019 for our operating leases is 4.3%.

10. Debt

The balances payable under all borrowing facilities are as follows:

The current portion of long-term debt as of September 28, 2019 includes the current portion of the foreign term loan, foreign revolving facility and the Schaublin mortgage, all of which are discussed below in further detail.

 Term Loan [Member]

CHF [Member] 

Domestic Credit Facility

On January 31, 2019, the Company amended the 2015 credit agreement with Wells Fargo Bank, National Association, as Administrative Agent, Collateral Agent, Swingline Lender and Letter of Credit Issuer, and the other lenders party thereto (the “2015 Credit Agreement”). The 2015 Credit Agreement as so amended (the “Amended Credit Agreement”) now provides the Company with a $250,000 revolving credit facility (the “Revolver”) in place of the revolver provided in the 2015 Credit Agreement. The Revolver expires on January 31, 2024. Debt issuance costs associated with the Amended Credit Agreement totaled $852 and will be amortized through January 31, 2024 along with the unamortized debt issuance costs remaining from the 2015 Credit Agreement.

Amounts outstanding under the Revolver generally bear interest at (a) a base rate determined by reference to the higher of (1) Wells Fargo’s prime lending rate, (2) the federal funds effective rate plus 1/2 of 1% and (3) the one-month LIBOR rate plus 1%, or (b) LIBOR plus a specified margin, depending on the type of borrowing being made. The applicable margin is based on the Company’s consolidated ratio of total net debt to consolidated EBITDA at each measurement date. Currently, the Company’s margin is 0.00% for base rate loans and 0.75% for LIBOR loans.

The Amended Credit Agreement requires the Company to comply with various covenants, including among other things, a financial covenant to maintain a ratio of consolidated net debt to adjusted EBITDA not greater than 3.50 to 1. The Amended Credit Agreement allows the Company to, among other things, make distributions to shareholders, repurchase its stock, incur other debt or liens, or acquire or dispose of assets provided that the Company complies with certain requirements and limitations of the Amended Credit Agreement. As of September 28, 2019, the Company was in compliance with all such covenants.

The Company’s domestic subsidiaries have guaranteed the Company’s obligations under the Amended Credit Agreement. The Company’s obligations under the Amended Credit Agreement and the domestic subsidiaries’ guarantee are secured by a pledge of substantially all of the domestic assets of the Company and its domestic subsidiaries.

Approximately $3,850 of the Revolver is being utilized to provide letters of credit to secure the Company’s obligations relating to certain insurance programs. As of September 28, 2019, $1,715 in unamortized debt issuance costs remain. The Company has the ability to borrow up to an additional $236,900 under the Revolver as of September 28, 2019.

Foreign Term Loan and Revolving Credit Facility

On August 15, 2019, one of our foreign divisions, Schaublin SA (“Schaublin”), entered into two separate credit agreements (the “Schaublin Credit Agreements”) with Credit Suisse (Switzerland) Ltd. to (i) finance the acquisition of Swiss Tool, which is discussed in further detail in Note 13, and (ii) provide future working capital. The Schaublin Credit Agreements provided Schaublin with a CHF 15,000 (approximately $15,383) term loan (the “Foreign Term Loan”), which expires on August 15, 2024 and a CHF 15,000 (approximately $15,383) revolving credit facility (the “Foreign Revolver”), which continues in effect until terminated by either Schaublin or Credit Suisse. Debt issuance costs associated with the Schaublin Credit Agreements totaled CHF 270 (approximately $277) and will be amortized throughout the life of the credit agreements.

Amounts outstanding under the Foreign Term Loan and the Foreign Revolver generally bear interest at LIBOR plus a specified margin. The applicable margin is based on Schaublin’s ratio of total net debt to consolidated EBITDA at each measurement date. Currently, Schaublin’s margin is 2.00%.

The Foreign Credit Agreements require Schaublin to comply with various covenants which are tested annually on March 31. These covenants include, among other things, a financial covenant to maintain a ratio of consolidated net debt to adjusted EBITDA not greater than 3.00 to 1 as of March 31, 2020 and not greater than 2.50 to 1 as of March 31, 2021 and thereafter. Schaublin is also required to maintain an economic equity of CHF 20,000 at all times. The Foreign Credit Agreements allow Schaublin to, among other things, incur other debt or liens and acquire or dispose of assets provided that Schaublin complies with certain requirements and limitations of the Foreign Credit Agreements. As of September 28, 2019, Schaublin was in compliance with all such covenants.

Schaublin's parent company, Schaublin Holding, has guaranteed Schaublin’s obligations under the Foreign Credit Agreements. Schaublin Holding's guaranty and the Foreign Credit Agreements are secured by a pledge of the capital stock of Schaublin. In addition, the Foreign Term Loan is secured with pledges of the capital stock of the top company and the three operating companies in the Swiss Tool System group of companies.

As of September 28, 2019, there was approximately $9,279 outstanding under the Foreign Revolver and approximately $15,129 outstanding under the Foreign Term Loan. As of September 28, 2019, approximately $263 in unamortized debt issuance costs remain. Schaublin has the ability to borrow up to an additional $5,850 under the Foreign Revolver as of September 28, 2019.

Schaublin’s required future annual principal payments for the next five years and thereafter are $0 for fiscal 2020, approximately $12,305 for fiscal 2021, approximately $3,026 for each year from fiscal 2022 through fiscal 2024 and approximately $3,025 thereafter.

Other Notes Payable

On October 1, 2012, Schaublin purchased the land and building that it occupied and had been leasing for approximately $14,910. Schaublin obtained a 20-year fixed-rate mortgage of approximately $9,857 at an interest rate of 2.9%. The balance of the purchase price of approximately $5,053 was paid from cash on hand. The balance on this mortgage as of September 28, 2019 was approximately $6,097.

11. Income Taxes

The Company files income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to state or foreign income tax examinations by tax authorities for years ending before April 2, 2005. The Company is no longer subject to U.S. federal tax examination by the Internal Revenue Service for years ending before April 2, 2016.

The effective income tax rates for the three-month periods ended September 28, 2019 and September 29, 2018, were 14.7% and 11.7%. In addition to discrete items, the effective income tax rates for these periods are different from the U.S. statutory rates due to the foreign-derived intangible income provision and U.S. credit for increasing research activities which decrease the rate and state income taxes which increase the rate.

The effective income tax rate for the three-month period ended September 28, 2019 of 14.7% includes $2,529 of tax benefit associated with share-based compensation. The effective income tax rate without this benefit and other items would have been 21.3%. The effective income tax rate for the three-month period ended September 29, 2018 of 11.7% includes $3,176 of tax benefit associated with share-based compensation. The effective income tax rate without this benefit and other items would have been 20.9%. The Company believes it is reasonably possible that some of its unrecognized tax positions may be effectively settled within the next twelve months due to the closing of audits and the statute of limitations expiring in various jurisdictions. The decrease in the Company’s unrecognized tax positions, pertaining primarily to federal and state credits and state tax, is estimated to be approximately $1,246.

Income tax expense for the six-month period ended September 28, 2019 was $12,646 compared to $9,777 for the six-month period ended September 29, 2018. Our effective income tax rate for the six-month period ended September 28, 2019 was 17.0% compared to 14.5% for the six-month period ended September 29, 2018. The effective income tax rate for the six-month period ended September 28, 2019 of 17.0% includes $3,039 of tax benefit associated with share-based compensation and $241 of tax benefit associated with other permanent adjustments from filing the Company's fiscal 2018 foreign tax returns. The effective income tax rate without these benefits and other items for the six-month period ended September 28, 2019 would have been 21.3%. The effective income tax rate for the six-month period ended September 29, 2018 of 14.5% included $4,506 of tax benefits associated with share-based compensation. The effective income tax rate without this benefit and other items for the six-month period ended September 29, 2018 would have been 21.3%.

12. Reportable Segments

The Company operates through operating segments for which separate financial information is available, and for which operating results are evaluated regularly by the Company’s chief operating decision maker in determining resource allocation and assessing performance. Those operating segments are aggregated as reportable segments as they have similar economic characteristics, including nature of the products and production processes, distribution patterns and classes of customers.

The Company has four reportable business segments, Plain Bearings, Roller Bearings, Ball Bearings and Engineered Products, which are described below.

Plain Bearings. Plain bearings are produced with either self-lubricating or metal-to-metal designs and consists of several sub-classes, including rod end bearings, spherical plain bearings and journal bearings. Unlike ball bearings, which are used in high-speed rotational applications, plain bearings are primarily used to rectify inevitable misalignments in various mechanical components.

Roller Bearings. Roller bearings are anti-friction bearings that use rollers instead of balls. The Company manufactures four basic types of roller bearings: heavy-duty needle roller bearings with inner rings, tapered roller bearings, track rollers and aircraft roller bearings.

Ball Bearings. The Company manufactures four basic types of ball bearings: high precision aerospace, airframe control, thin section and commercial ball bearings which are used in high-speed rotational applications.

Engineered Products. Engineered Products consists of highly engineered hydraulics, fasteners, collets and precision components used in aerospace, marine and industrial applications.

Segment performance is evaluated based on segment net sales and gross margin. Items not allocated to segment operating income include corporate administrative expenses and certain other amounts.

  Corporate [Member]

All intersegment sales are eliminated in consolidation.

13. Acquisition

 CHF [Member]

On August 15, 2019, the Company, through its Schaublin SA subsidiary, acquired all of the outstanding shares of Vianel Holding AG (“Swiss Tool”) for a purchase price of approximately $33,842 (CHF 33,000), subject to a working capital adjustment. Swiss Tool, which is based in Bürglen, Switzerland, owns Swiss Tool Systems AG and other subsidiaries which collectively develop and manufacture high precision boring and turning solutions for metal cutting machines under the Swiss Tool Systems name. The preliminary purchase price allocation is as follows: accounts receivable ($1,325), inventory ($5,963), other current assets ($586), fixed assets ($3,487), intangible assets ($13,635), operating lease assets ($2,851), other non-current assets ($154), accounts payable ($562), other current liabilities ($894), operating lease liabilities ($2,851), deferred tax liabilities ($3,480) and noncurrent liabilities ($2,085). The purchase price allocation, which resulted in goodwill of approximately $15,625, is not deductible for tax purposes and is subject to change pending a final valuation of the assets and liabilities, including intangible assets and deferred income taxes. Swiss Tool is included in the Engineered Products reporting segment.

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement As To Forward-Looking Information

The information in this discussion contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which are subject to the “safe harbor” created by those sections. All statements other than statements of historical facts, included in this quarterly report on Form 10-Q regarding our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management are “forward-looking statements” as the term is defined in the Private Securities Litigation Reform Act of 1995.

The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation: (a) the bearing and engineered products industries are highly competitive, and this competition could reduce our profitability or limit our ability to grow; (b) The loss of a major customer, or a material adverse change in a major customer’s business, could result in a material reduction in our revenues, cash flows and profitability; (c) weakness in any of the industries in which our customers operate, as well as the cyclical nature of our customers' businesses generally, could materially reduce our revenues, cash flows and profitability; (d) future reductions or changes in U.S. government spending could negatively affect our business; (e) fluctuating supply and costs of subcomponents, raw materials and energy resources, or the imposition of import tariffs, could materially reduce our revenues, cash flows and profitability; (f) our results could be impacted by changes in trade agreements or treaties and the imposition of tariffs on our goods exported to other countries; (g) our products are subject to certain approvals and government regulations and the loss of such approvals, or our failure to comply with such regulations, could materially reduce our revenues, cash flows and profitability; (h) the retirement of commercial aircraft could reduce our revenues, cash flows and profitability; (i) work stoppages and other labor problems could materially reduce our ability to operate our business; (j) unexpected equipment failures, catastrophic events or capacity constraints could increase our costs and reduce our sales due to production curtailments or shutdowns; (k) we may not be able to continue to make the acquisitions necessary for us to realize our growth strategy; (l) businesses that we have acquired or that we may acquire in the future may have liabilities which are not known to us; (m) goodwill and indefinite-lived intangibles comprise a significant portion of our total assets, and if we determine that goodwill and indefinite-lived intangibles have become impaired in the future, our results of operations and financial condition in such years may be materially and adversely affected; (n) we depend heavily on our senior management and other key personnel, the loss of whom could materially affect our financial performance and prospects; (o) our international operations are subject to risks inherent in such activities; (p) currency translation risks may have a material impact on our results of operations; (q) we are subject to changes in legislative, regulatory and legal developments involving income and other taxes; (r) we may be required to make significant future contributions to our pension plan; (s) we may incur material losses for product liability and recall-related claims; (t) environmental and health and safety laws and regulations impose substantial costs and limitations on our operations, and environmental compliance may be more costly than we expect; (u) our intellectual property and proprietary information are valuable, and any inability to protect them could adversely affect our business and results of operations; in addition, we may be subject to infringement claims by third parties; (v) cancellation of orders in our backlog could negatively impact our revenues, cash flows and profitability; (w) if we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud; (x) litigation could adversely affect our financial condition; (y) changes in accounting standards or changes in the interpretations of existing standards could affect our financial results; (z) risks associated with utilizing information technology systems could adversely affect our operations. Additional information regarding these and other risks and uncertainties is contained in our periodic filings with the SEC, including, without limitation, the risks identified under the heading “Risk Factors” set forth in the Annual Report on Form 10-K for the year ended March 30, 2019. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may make. We do not intend, and undertake no obligation, to update or alter any forward-looking statement. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Quarterly Report.

Overview

We are a well-known international manufacturer and maker of highly engineered precision bearings and components. Our precision solutions are integral to the manufacture and operation of most machines and mechanical systems, reduce wear to moving parts, facilitate proper power transmission and reduce damage and energy loss caused by friction. While we manufacture products in all major bearings categories, we focus primarily on the higher end of the bearing and engineered component markets where we believe our value added manufacturing and engineering capabilities enable us to differentiate ourselves from our competitors and enhance profitability. We believe our unique expertise has enabled us to garner leading positions in many of the product markets in which we primarily compete. With 43 facilities, of which 33 are manufacturing facilities in four countries, we have been able to significantly broaden our end markets, products, customer base and geographic reach. We currently operate under four reportable business segments: Plain Bearings; Roller Bearings; Ball Bearings; and Engineered Products. The following further describes these reportable segments:

Plain Bearings. Plain bearings are produced with either self-lubricating or metal-to-metal designs and consists of several sub-classes, including rod end bearings, spherical plain bearings and journal bearings. Unlike ball bearings, which are used in high-speed rotational applications, plain bearings are primarily used to rectify inevitable misalignments in various mechanical components.

Roller Bearings. Roller bearings are anti-friction bearings that use rollers instead of balls. We manufacture four basic types of roller bearings: heavy-duty needle roller bearings with inner rings, tapered roller bearings, track rollers and aircraft roller bearings.

Ball Bearings. We manufacture four basic types of ball bearings: high precision aerospace, airframe control, thin section and commercial ball bearings which are used in high-speed rotational applications.

Engineered Products. Engineered Products consists of highly engineered hydraulics, fasteners, collets and precision components used in aerospace, marine and industrial applications.

Purchasers of bearings and engineered products include industrial equipment and machinery manufacturers, producers of commercial and military aerospace equipment such as missiles and radar systems, agricultural machinery manufacturers, construction, energy, mining, marine and specialized equipment manufacturers, marine products, automotive and commercial truck manufacturers. The markets for our products are cyclical, and we have endeavored to mitigate this cyclicality by entering into sole-source relationships and long-term purchase agreements, through diversification across multiple market segments within the aerospace and defense and diversified industrial segments, by increasing sales to the aftermarket and by focusing on developing highly customized solutions.

Currently, our strategy is built around maintaining our role as a leading manufacturer of precision-engineered bearings and components through the following efforts:

Outlook

Our net sales for the three-month period ended September 28, 2019 increased 5.2% compared to the same period last fiscal year. The increase in net sales was a result of a 10.2% increase in aerospace sales partially offset by a decrease of 2.8% in industrial sales. Excluding $3.9 million of sales associated with the Miami division sold in fiscal 2019, aerospace sales increased 14.4% year over year. The increase in aerospace markets was primarily due to the commercial and defense OEM and aftermarket business. Excluding $1.5 million of sales from the Swiss Tool acquisition in fiscal 2020, industrial sales decreased 5.0% year over year. The decrease in industrial sales was driven by energy and general industrial markets. Overall, excluding sales associated with the Miami division and Swiss Tool, net sales increased 6.8% year over year. Our backlog as of September 28, 2019 was $473.2 million compared to $429.9 million as of September 29, 2018.

The Company expects net sales to be approximately $177.0 million to $179.0 million in the third quarter of fiscal 2020. This would result in a growth rate of 3.2% to 4.4% on a year-over-year basis and 3.6% to 4.7% excluding $2.9 million in sales associated with our Miami division, which was sold in the third quarter of fiscal 2019, and $2.5 million of sales associated with Swiss Tool, which we acquired in the second quarter of fiscal 2020. The third quarter will be impacted by approximately four to five fewer production and shipping days due to the holiday schedule.

Management believes that operating cash flows and available credit under all credit agreements will provide adequate resources to fund internal and external growth initiatives for the foreseeable future. As of September 28, 2019, we had cash and cash equivalents of $36.4 million of which approximately $18.2 million was cash held by our foreign operations.

Results of Operations

(dollars in millions)

Our net sales for the three-month period ended September 28, 2019 increased 5.2% compared to the same period last fiscal year. The increase in net sales was a result of a 10.2% increase in aerospace sales partially offset by a decrease of 2.8% in industrial sales. Excluding $3.9 million of sales associated with the Miami division sold in fiscal 2019, aerospace sales increased 14.4% year over year. The increase in aerospace markets was primarily due to the commercial and defense OEM and aftermarket business. Excluding $1.5 million of sales from the Swiss Tool acquisition in fiscal 2020, industrial sales decreased 5.0% year over year. The decrease in industrial sales was driven by energy and general industrial markets. Overall, excluding sales associated with the Miami division and Swiss Tool, net sales increased 6.8% year over year.

Net income for the second quarter of fiscal 2020 was $31.3 million compared to $30.1 million for the same period last year. Net income for the second quarter of fiscal 2020 was affected by $2.5 million of tax benefit associated with share-based compensation partially offset by $0.8 million of after-tax costs associated with the acquisition of Swiss Tool, $0.1 million of losses on foreign exchange and $0.1 million of other discrete tax losses. Net income for the second quarter of fiscal 2019 was affected by $3.2 million of tax benefit associated with share-based compensation.

Net sales increased $15.7 million or 4.5% for the six-month period ended September 28, 2019 over the same period last year. The increase in net sales was mainly the result of a 10.8% increase in aerospace sales partially offset by a 5.1% decrease in industrial sales. Excluding $8.4 million of sales associated with the Miami division in fiscal 2019, aerospace sales increased 15.3% year over year. The increase in aerospace sales was primarily due to commercial and defense OEM and aftermarket business. Excluding $1.5 million of sales from the Swiss Tool acquisition in fiscal 2020, industrial sales decreased 6.1% year over year. The decrease in industrial sales was primarily due to mining, energy, and general industrial markets. Overall, excluding sales associated with the Miami division and Swiss Tool, net sales increased 6.6% year over year.

Net income for the six months ended September 28, 2019 was $61.8 million compared to $57.6 million for the same period last year. The net income of $61.8 million in fiscal 2020 was impacted by $3.0 million of tax benefits associated with share-based compensation and $0.2 million of discrete tax benefits partially offset by $0.8 million of after-tax cost associated with the acquisition of Swiss Tool and $0.3 million of loss on foreign exchange. The net income of $57.6 million in fiscal 2019 was impacted by $4.5 million of tax benefits associated with share-based compensation and $0.1 million associated with foreign exchange and discrete taxes and $0.8 million of after-tax cost associated with the loss on the extinguishment of debt.

Gross Margin

Gross margin increased $3.3 million, or 4.9%, in the second quarter of fiscal 2020 compared to the second quarter of fiscal 2019. This was mainly driven by higher sales achieved during the current period. The exclusion of the Miami division in fiscal 2020 also benefited gross margin percentage compared to the prior period.

Gross margin increased $6.2 million or 4.6% for the first six months of fiscal 2020 compared to the same period last year. The increase year over year is primarily a result of higher sales achieved during the period. The exclusion of the Miami division in fiscal 2020 also benefited gross margin percentage compared to the prior period.

Selling, General and Administrative

SG&A expenses increased by $1.5 million to $30.8 million for the second quarter of fiscal 2020 as compared to $29.3 million for the second quarter of fiscal 2019. This increase was mainly driven by $1.0 million of additional share-based compensation expense, $0.4 million of personnel-related expenses, and $0.1 million of other costs. As a percentage of sales, SG&A was 16.9% for the second quarter of fiscal 2020 compared to 17.0% for the same period last year.

SG&A expenses increased by $2.0 million to $60.9 million for the first six months of fiscal 2020 compared to $58.9 million for the same period last year. This increase is primarily due to $2.0 million of additional share-based compensation.

Other, Net

Other operating expenses for the second quarter of fiscal 2020 totaled $3.0 million compared to $2.6 million for the same period last year. For the second quarter of fiscal 2020, other operating expenses were comprised mainly of $2.3 million of amortization of intangible assets and $0.9 million of costs associated with the acquisition of Swiss Tool, partially offset by $0.2 million of other income. For the second quarter of fiscal 2019, other operating expenses were comprised mainly of $2.6 million of amortization of intangible assets.

Other operating expenses for the first six months of fiscal 2020 totaled $5.1 million compared to $4.8 million for the same period last year. For the first six months of fiscal 2020, other operating expenses were comprised mainly of $4.6 million in amortization of intangibles and $0.9 million of costs associated with the acquisition of Swiss Tool, partially offset by $0.4 million of other income. For the first six months of fiscal 2019, other operating expenses were comprised mainly of $4.9 million in amortization of intangibles offset by $0.1 million of other income.

Interest Expense, Net

Interest expense, net, generally consists of interest charged on the Company’s bank credit facilities and amortization of deferred financing fees, offset by interest income (see “Liquidity and Capital Resources – Liquidity” below). Interest expense, net was $0.5 million for the second quarter of fiscal 2020 compared to $1.4 million for the same period last year. The Company had total debt of $37.8 million at September 28, 2019 compared to $124.5 million at September 29, 2018.

Interest expense, net was $1.0 million for the first six months of fiscal 2020 compared to $3.2 million for the first six months of fiscal 2019.

Income Taxes

Income tax expense for the three-month period ended September 28, 2019 was $5.4 million compared to $4.0 million for the three-month period ended September 29, 2018. Our effective income tax rate for the three-month period ended September 28, 2019 was 14.7% compared to 11.7% for the three-month period ended September 29, 2018. The effective income tax rate for the three-month period ended September 28, 2019 of 14.7% includes $2.5 million of tax benefit associated with share-based compensation. The effective income tax rate without these benefits and other items for the three-month period ended September 28, 2019 would have been 21.3%. The effective income tax rate for the three-month period ended September 29, 2018 of 11.7% includes $3.2 million of tax benefit associated with share-based compensation. The effective income tax rate without this benefit and other items for the three-month period ended September 29, 2018 would have been 20.9%.

Income tax expense for the six-month period ended September 28, 2019 was $12.6 million compared to $9.8 million for the six-month period ended September 29, 2018. Our effective income tax rate for the six-month period ended September 28, 2019 was 17.0% compared to 14.5% for the six-month period ended September 29, 2018. The effective income tax rate for the six-month period ended September 28, 2019 of 17.0% includes $3.0 million of tax benefit associated with share-based compensation and $0.2 million of tax benefit associated with other permanent adjustments from filing the Company’s fiscal 2018 foreign tax returns. The effective income tax rate without these benefits and other items for the six-month period ended September 28, 2019 would have been 21.3%. The effective income tax rate for the six-month period ended September 29, 2018 of 14.5% includes $4.5 million of tax benefits associated with share-based compensation. The effective income tax rate without this benefit and other items for the six-month period ended September 29, 2018 would have been 21.3%.

Acquisition

On August 15, 2019, the Company, through its Schaublin SA subsidiary, acquired all of the outstanding shares of Vianel Holding AG (“Swiss Tool”) for a purchase price of approximately $33.8 million (CHF 33.0 million), subject to a working capital adjustment. Swiss Tool, which is based in Bürglen, Switzerland, owns Swiss Tool Systems AG and other subsidiaries which collectively develop and manufacture high precision boring and turning solutions for metal cutting machines under the Swiss Tool Systems name. The preliminary purchase price allocation is as follows: accounts receivable ($1.3 million), inventory ($6.0 million), other current assets ($0.6 million), fixed assets ($3.5 million), intangible assets ($13.6 million), operating lease assets ($2.9 million), other non-current assets ($0.2 million), accounts payable ($0.6 million), other current liabilities ($0.9 million), operating lease liabilities ($2.9 million), deferred tax liabilities ($3.5 million) and noncurrent liabilities ($2.0 million). The purchase price allocation, which resulted in goodwill of approximately $15.6 million, is not deductible for tax purposes and is subject to change pending final valuation of the asset and liabilities, including intangible assets and deferred income taxes. Swiss Tool is included in the Engineered Products reporting segment.

Segment Information

We have four reportable product segments: Plain Bearings, Roller Bearings, Ball Bearings and Engineered Products. We use gross margin as the primary measurement to assess the financial performance of each reportable segment.

Plain Bearing Segment

Net sales increased $12.5 million, or 16.2%, for the three months ended September 28, 2019 compared to the same period last year. The 16.2% increase was primarily driven by an increase of 21.6% in our aerospace markets and a 0.3% increase in our industrial markets. The increase in aerospace was primarily due to commercial and defense, both OEM and aftermarket.

Gross margin as a percent of sales was 39.7% for the second quarter of fiscal 2020 compared to 39.8% for the same period last year.

Net sales increased $21.5 million, or 13.8%, for the six months ended September 28, 2019 compared to the same period last year. The 13.8% increase was primarily driven by an increase of 20.5% in our aerospace markets partially offset by a 4.5% decrease in the industrial markets. The increase in aerospace was primarily due to commercial and defense, both OEM and aftermarket. The decrease in industrial sales was mostly driven by the mining, distribution and the general industrial markets.

Gross margin as a percent of sales decreased to 39.3% for the first six months of fiscal 2020 compared to 39.4% for the same period last year.

Roller Bearing Segment