RBC Bearings Incorporated (NYSE:RBC) Q2 2023 Earnings Conference Call November 10, 2022 11:00 AM ET
Company Participants
Josh Carroll – Investor Relations
Michael Hartnett – Chairman, President & Chief Executive Officer
Robert Sullivan – Vice President & Chief Financial Officer
Daniel Bergeron – Director, Vice President & Chief Operating Officer
Conference Call Participants
Joe Ritchie – Goldman Sachs
Steve Barger – KeyBanc Capital Markets
Larry Stavitski – Wells Fargo.
Elizabeth Grenfell – Bank of America
Pete Skibitski – Alembic Global
Pete Osterland – Truist Securities
Operator
Welcome to RBC Bearings Second Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded.
I will now turn the conference over to Josh Carroll, Investor Relations. You may begin.
Josh Carroll
Good morning and thank you for joining us for RBC Bearings fiscal 2023 second quarter earnings conference call. With me on the call today are Dr. Michael J. Hartnett, Chairman, President, and Chief Executive Officer; Daniel A. Bergeron, Director, Vice President and Chief Operating Officer; and Robert Sullivan, 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.
With that, I will now turn the call over to Dr. Hartnett.
Michael Hartnett
Okay. Thank you, Josh and good morning everyone and welcome. I’ll go through the introduction here and then turn it over to Rob. Net sales for the second quarter of 2023 were $369.2 million versus $160.9 million for the same period last year, an increase of 129.4%.
The second quarter of 2023 our sales of our industrial products represented 72% of net sales and aerospace products 28%. Gross margin for the quarter was $151.1 million or 40.9% of net sales. This compares with $62.5 million or 38.8% for the same period last year.
Adjusted operating income was $76 million, 20.6% of net sales compared to last year of $20 million and 12.4% respectively. GAAP EPS was $1.31. Adjusted EPS came in at $1.93 per share.
Adjusted EBITDA was $108.8 million, 29.5% of net sales compared to $45.4 million and 28.2% of net sales for the same period last year. During the period, we paid down debt of another $45 million on the term loan and had free cash flow of $14.1 million.
We entered the second quarter with continued strength in the industrial sector and a good outlook for the balance of our fiscal year. Sales of industrial products were up 290.7% from last year. RBC’s organic growth for the industrial products 7.9%, Dodge expanded at 16.2% rate. So, that average rate for industrial growth was somewhere around 14%.
Weakness from Europe reduced the classic growth rate from double-digit expansion on the RBC side of the coin. Major markets of mining, aggregate, oil and gas, food and beverage, grain, semiconductor, machinery, and general industrial distribution continue to perform well.
Turning now to aerospace and defense. Overall, the second quarter of 2023, net sales were up 11.4%. Commercial aerospace expanded at a rate of 31.3%. Expansion of production levels at Boeing and Airbus were the obvious prime drivers here. As you know we are in a very early innings of a multiyear expansion with these majors.
We remain busy adding capacity in the forms of capital and staff to our manufacturing sites in order to support future quarter-to-quarter demand requirements, putting this all back together again after the pandemic and Boeing’s problems.
A word on our defense business, this business contracted 15.3%. The delay in shipping products within the quarter as a result of normal production delays and a short fall in order rate from historical norms for government spares on military aircraft platforms explains most of that variance.
It’s disturbing to see the deferred maintenance of our important defense aircraft continues with low grades of fleet readiness are reported by the Air Force Times. The sophisticated materials needed to produce replacement parts have at least a 52-week lead time. So this problem will be with us for some time. Obviously, fleet readiness should be a national defense priority. So, write to your congressmen.
Recently, we have had an unusual amount of inquiries for products associated with munitions used in Ukraine as well as other sophisticated weapon rate some of which have recently converted to orders.
Regarding the third quarter we are expecting sales to be between $348 million and $360 million.
And I’ll now turn the call over to Rob, for more detail on the financial performance.
Robert Sullivan
Thank you, Mike. SG&A for the second quarter of fiscal 2023 was $57.5 million, compared to $40.2 million for the same period last year. As a percentage of net sales SG&A was 15.6% for the second quarter, compared to 25% for the same period last year.
Looking forward, with fewer production days in the third quarter SG&A as a percentage of sales is expected to be closer to 16% to 16.5% of sales. Other operating expenses for the second quarter of fiscal 2023 totaled $21.6 million, compared to $5.7 million for the same period last year.
For the second quarter of fiscal 2023, other operating expenses included $16.8 million of amortization of intangible assets, $4 million of costs associated with the Dodge acquisition and $0.8 million of other expense.
For the second quarter of fiscal 2022, other operating expenses consisted primarily of $2.8 million of amortization of intangible assets, $1.4 million of acquisition costs, $1.1 million of restructuring costs and related items and $0.4 million of other items.
Operating income was $72 million for the second quarter of fiscal 2023, compared to operating income of $16.6 million for the same period in fiscal 2022. On an adjusted basis operating income would have been $76 million for the second quarter of fiscal 2023, compared to adjusted operating income of $20 million for the second quarter of fiscal 2022.
Interest expense for the second quarter of fiscal 2023 was $18.3 million, compared to $15.8 million for the same period last year. For the second quarter of fiscal 2023 the company reported net income of $43.8 million, compared to a net loss of $1.4 million for the same period last year.
On an adjusted basis, net income was $61.9 million for the second quarter of fiscal 2023, compared to $30.5 million for the same period last year. Net income available to common stockholders for the second quarter of fiscal 2023 was $38.1 million, compared to a net loss of $1.9 million for the same period last year.
On an adjusted basis, net income available to common stockholders for the second quarter of fiscal 2023 was $56.2 million, compared to $29.9 million for the same period last year. Diluted earnings per share, was $1.31 per share for the second quarter of fiscal 2023, compared to a loss of $0.07 per share for the same period last year.
On an adjusted basis, diluted earnings per share for the second quarter of fiscal 2023 was $1.93 per share, compared to adjusted diluted earnings per share of $1.16 per share for the same period last year.
Turning to cash flow, the company generated $29.3 million in cash from operating activities in the second quarter of fiscal 2023, compared to $40.2 million for the same period last year. Our cash from operations in the current quarter was impacted by continued strategic investments in our inventory and the timing of certain tax payments.
Capital expenditures were $15.2 million in the second quarter of fiscal 2023 which in addition to our traditional capital spend reflects certain costs to transition our IT systems hardware and applications from ABB to RBC as we rolled off the TSA.
This compared to $3.5 million of capital expenditures for the same period last year. We paid down $45 million on the term loan during the period leaving total debt of $1.52 billion as of October 1st 2022 and cash on hand was $88.5 million.
I would now like to turn the call back to the operator, for the question-and-answer session.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question is from Joe Ritchie with Goldman Sachs. Please proceed.
Joe Ritchie
Thank you. Good morning everybody.
Michael Hartnett
Good morning.
Daniel Bergeron
Good morning.
Robert Sullivan
Good morning.
Joe Ritchie
Hey guys. Last quarter we talked a little bit about supply chain issues. And I was just curious just obviously you put up a pretty healthy growth in the industrial sector and also in A&D. But I just want to see like what update can you kind of give us on how supply chain is evolving for you?
Michael Hartnett
Yeah. Sure Joe. Well, supply chain is — continues to be a problem. And there’s — it’s something that we have to — we actually have to work on every day. It continues to bite us in sensitive places. And so we continue to develop countermeasures to reverse its impact.
So the difficult thing is our materials for the most part are not simple materials. They’re sophisticated steels and titaniums and aluminum. And sometimes the specifications can be extreme. The lead time on a lot of these materials has moved out past 50 weeks.
So that means your planning horizon, just is another six months into your planning horizon when you’re trying to plan your plants. So you have to make adjustments for that. There’s prohibitions on supply from China now on certain defense products that were approved in the past. So that makes it more difficult particularly when there’s not many US suppliers producers of some of these components. And so far it’s manageable, but it’s difficult. And in the materials in many cases, the price of these materials has doubled. And so we have to work on our contracts and making sure that we’re passing through the amount of economics that’s required in order to normalize the margins. So it’s definitely — it definitely keeps everybody busy, and it certainly a reason to get up early and get to work.
Joe Ritchie
That’s helpful context. And a good segue into my next question, which is really just around the pricing that you’re putting through. I know that the vast majority of the revenues that came in from Dodge, go through distribution. And so I’m curious, like, if there’s any other specific color you can tell us about how much pricing is coming through today? What’s your expectation on the industrial side of your business for pricing as we head into calendar year 2023?
Michael Hartnett
Well, I think everybody knows what inflation is doing and that certainly gets into the manufacturing cost of our products. And we have to have the right metrics to measure it and make sure that we reflect it in price changes to the marketplace. I mean, it’s not that we’re unique in this. I mean, the whole — the baseline for all the suppliers is — changes monthly. So it’s definitely an area we haven’t had to consider, so carefully in past years. But it’s one thing about manufacturing products there’s always a different problem to solve.
Joe Ritchie
And, I mean, Mike maybe just a quick follow-on on that one. Do you anticipate just how your contracts are set up that you’re going to have to give back any pricing next year if we actually start to see deflation? Obviously, the market is acting well today on the hopefully getting closer to a peak inflation number. Just any thoughts around that would be helpful.
Michael Hartnett
You mean if the inflation number goes negative then we have…
Joe Ritchie
Well, it’s a couple of things — yeah. No, this is more of a comment around like your costs, because you’ve had pretty significant material deflation already in the last couple of quarters. I’m just curious; do you have two-way price material formulas with your distributors or with your OEMs, or you’d have to give back some of that pricing?
Michael Hartnett
Well, if the baseline changes from $1 to $1.50 and if inflation goes from whatever it was last quarter, 8% to 2%, we’re going to see a 2% adjustment on $1.50 and that adjustment will be up. If it goes negative then we’ll adjust it down. But we’re not anticipating any negativity in inflation for a long time to come.
Joe Ritchie
Okay, understood. Thank you.
Operator
Our next question is from Steve Barger with KeyBanc Capital Markets. Please proceed.
Steve Barger
Thanks. Good morning.
Robert Sullivan
Good morning.
Michael Hartnett
Good morning.
Steve Barger
Mike, I’d like to get your take on the industrial cycle. The September and October PMI readings were around 50%, but September industrial production was still 5.3%. So they’re both still showing growth but obviously IP is a lot stronger. How are you incorporating that backdrop into your production planning, or do you even look at that or just listen to your customers? Just how are you thinking about the cycle?
Michael Hartnett
Well, the — it’s a simple question with a complex answer Steve, just because of the number of different markets that we’re in. And all of these markets have their own little economic strength or weakness. And so in a lot of cases, we will have long-term agreements with these customers that protect the supply side for us. And we look at what their demand outlook is. For example, how many ships has Boeing got to produce in a given month? And what’s our mix and at what rate should we be running that sort of thing?
So, then we roll it all up into a business plan. In many cases, particularly on the Dodge side of the business, that’s really driven a lot by the PMI index and other economic indexes, because basically Dodge is an in and out business where RBC historically, is a business that has contracts and long-term agreements and backlog. So you have to be just a little bit closer — you’re a little bit closer to the economy, the Dodge side than you are on the RBC side.
So with Dodge, yes, we have models and we have economic inputs that basically give us a forecast of demand going forward for each product line. And from that forecasted demand, we decide whether or not the forecaster is crazy or we should believe him and decide at what rate we should load the plants, to produce these products. For the most part on the Dodge side, that’s hugely dependent upon US consumption. How much grain, how much aggregate, how many materials that sort of thing. Food and beverage, how much consumption is going on. And that’s a big economic driver for Dodge. So that’s how we do it.
Steve Barger
So, what are your thoughts as you go into the next few quarters on the Dodge side, knowing that it is closer to the real economy, are you expecting that that’s going to moderate in terms of, growth rates, or does it still seem pretty robust, as far as you can see?
Michael Hartnett
Yes. I think for the balance of our fiscal year, I mean I don’t like to get out too far, because I don’t like to go beyond the fiscal year, but I think for the balance of our fiscal year, we expect the industrial businesses to perform in the low double digits.
Steve Barger
Organically low double digits. Okay.
Michael Hartnett
Yes.
Steve Barger
Got it. And I know the pace of commercial aerospace has been a hard to predict over the past couple of years. But if we do track to the multiyear expansion you’re expecting, how are you thinking about normalized commercial aero growth rates in — and I know you don’t like to get too far out, but you do have contracts on that business. Just how are you thinking about the back half of 2023 and into 2024 fiscal for you?
Michael Hartnett
Well, I think the commercial growth rate are demonstrated in the second quarter, at the OEM level was a 30% kind of number. Yes. I think we’re going to be living there for a while.
Steve Barger
Got it. And well — and so and presumably, you expect the defense side to improve from I think it was down 15 this quarter, because of those — some of those shipping delays.
Michael Hartnett
Yes. It’s — on the defense side, we make very complicated sophisticated products that require all sorts of outside processing and government buy-offs. And so it’s — it just — it all doesn’t happen in a quarter.
Steve Barger
Right. Okay. One more and I’ll jump back in line. First half free cash flow was $65 million. I know that included some of the cash transition and integration costs. Can you tell us, what you expect in the back half for operating cash flow and CapEx or just free cash flow if it’s easier?
Robert Sullivan
Let me put it this way for you, Steve. I mean the first — this quarter alone we continued that strategic inventory build that $17 million. We had Dodge cost to stand up their systems kind of pay the TSA. That’s close to $10 million. And then we had timing of two [indiscernible] tax payments coming through. So we had $34 million of tax payments this quarter. We’ll have one tax payment in Q3, one in Q4. So it starts to spread out. So I think we’ll start to see that operating cash escalate, as we get to the back half of the year.
Steve Barger
So I mean essentially all those things that you just mentioned — well I guess, you said some of the tax falls, in the back half or that was in 2Q?
Robert Sullivan
In Q2, we had two payments. In Q3, we’ll have one. In Q4, we’ll have one. So it was just the timing and we got hit hard. The Dodge…
Steve Barger
Understood
Robert Sullivan
…cost should start to fall off. Obviously, the TSA goes away in November.
Steve Barger
And would you expect the inventory build to moderate in the back half, or just given the growth rates Mike just talked about, you’re still going to be running ahead on working cap?
Michael Hartnett
Yes. We’re working hard to liquidate some of that some of that inventory build, is a result of supply chain mismatch, if you’re making an assembly and you get all your castings but you didn’t get the seal for the bearing, you can’t ship the assembly. So some simple things can tie up a lot of working capital.
Steve Barger
Understood. Thanks.
Operator
Our next question is from Seth Weber with Wells Fargo. Please proceed.
LarryStavitski
Hi, guys. How are you? It’s actually Larry Stavitski on for Seth today. Thanks for taking my questions.
Michael Hartnett
Hi, Larry.
Larry Stavitski
I first wanted to ask about gross margins or margins. They were better than we expected, up about 100 basis points sequentially. Where do you see the trajectory of gross margins going for the balance of the year given your price cost expectations?
Robert Sullivan
I think we’ll continue to see some strength in the gross margin space. I think Q2 was obviously an exceptionally strong quarter. Third quarter with the fewer production days things tend to moderate a bit. And then the fourth quarter tends to be a stronger quarter for us as well.
Larry Stavitski
Okay. But are you thinking – I mean you’ve been at or above 40 or so for the last couple of quarters. Is that kind of – is that…
Robert Sullivan
Yes. I think that’s about where we’re living these days.
Michael Hartnett
It’s not in the neighborhood.
Larry Stavitski
Yes. For sure, for sure. Okay, thanks. And then I just wanted to follow up on China. I know you had some manufacturing issues there. Last quarter you guys got kind of a little bit jammed up. Just I guess can you talk about the production dynamics that you’re seeing there with COVID and the regional dynamics there?
Daniel Bergeron
Yes. Right now Seth, in Q2 was back to normal. In Q3, I think we missed about one month 1.5 months of shipments – in Q1 sorry. And Q2 we’re back to normal. And Q3 we’re projecting to be back to. But as a total sales it’s just not a big number.
Larry Stavitski
Right. Okay.
Daniel Bergeron
And it was about $6 million this quarter.
Larry Stavitski
$6 million this quarter? Okay.
Daniel Bergeron
Yes. It’s not a huge contributor to the top line.
Larry Stavitski
Great. Okay. Got you. Okay. Thanks, I’ll pass it on, guys. Appreciate it.
Operator
Our next question is from Elizabeth Grenfell with Bank of America. Please proceed.
Elizabeth Grenfell
Hi, good morning.
Michael Hartnett
Good morning.
Elizabeth Grenfell
How should we think about CapEx for the rest of this year and then going into next year and out from there?
Robert Sullivan
Sure. So this quarter reflected some of those Dodge system implementation costs that we had as we rolled off of the TSA. So when you back that out you kind of get back to our normal cadence between 2% and 3%, I think that’s the neighborhood we’re going to live in as we continue into the future.
Elizabeth Grenfell
Are there opportunities for additional CapEx related to Dodge that maybe weren’t anticipated a year ago?
Michael Hartnett
We’re not far enough along to answer that question and I’ll tell you why. It’s – their normalized CapEx usage is pretty much 3% of sales that sort of neighborhood. On the other hand, when we got involved with Dodge and sort of sort of went down the rabbit hole in terms of what they were developing in research and development.
We found some very promising new products that we need to bring forward and we’re not far enough along to know how much capital that’s going to require to support them. And – but overall, it should live within I think that 3% of sales ratio. We might go to 4% or something like that. But it’s – we don’t see big changes.
Elizabeth Grenfell
Okay. And then one other question. The adjusted EBITDA margin target over the long term I think is in the mid-30s. Can you talk to us about sort of the drivers behind that? And when you expect you’ll get there?
Michael Hartnett
Daniel? We’ll put the mid-30s and that’s the guy that should be speaking to it
Daniel Bergeron
Yes. I think – this is Dan. I think – I’m not sure where the mid-30s came from. But I think with all the work we’re doing on our integration and our synergy NPAT, we’ll continue to work toward – toward that number. And you can see our gross margins and our EBITDA margins now over this last 12 months have appreciated pretty well to where we thought we’d be for the first year and so all the things that we talked about on the synergy side all those programs have been started. And over the next three to four years, we should start seeing the benefit of that down to gross margin, operating income and EBITDA.
Elizabeth Grenfell
Okay. So, mid-30s is not an option or?
Michael Hartnett
Well, that’s not the floor that’s probably more like the ceiling and we’ll live somewhere between those two.
Elizabeth Grenfell
Got it. All right. Thank you. Thanks so much.
Operator
Our next question is from Pete Skibitski with Alembic Global. Please proceed.
Pete Skibitski
Hey, good morning, guys. Nice quarter.
Michael Hartnett
Good morning, Pete.
Pete Skibitski
Just want to be clear, how many fewer days does the third quarter have versus the second quarter? And are you expecting both of the segments to be lower sequentially in revenue?
Daniel Bergeron
Yeah, the factory is not open. We’re not shipping, right? So the fourth quarter we normally have no vacations. It’s a longer quarter on the four, five, so we pick up on average around seven days. Every facility is different Dodge is a little different. There’s a little less than we do in the third quarter where we have Thanksgiving for the RBC classic divisions. Most of them are closed down between Christmas and New Year’s.
Dodge shuts down part way over that holiday. So, all that impacts the production days and our shipments and one other thing impacting our shipments in Q3 is we went live on a new SAP system that we had to stand up from ABB. And we probably lost a few production days, which we’re trying to catch up. We went live in October. And we probably lost two to four days of just normalized production over that period of time. So that’s why our sales range for Q3 is so wide this time around. So we’ll see where we end up coming out by the end of December. And – but yeah, I mean, if you look at Q3 on average divide it by 60 days and multiply it by 67 days it kind of gives you the idea of what our or six-month quarter you could say it looks like when you add them both together.
Pete Skibitski
Okay. Okay. And then I just want to ask on defense, with the softness this quarter and we’re in a continuing resolution now right for the federal government for your fiscal third quarter. Has visibility improved there at all in terms of are you expecting another – even if you adjusted for fewer working days in your third quarter would, would defense sales still be down in the third quarter? Is it going to be a situation where maybe we have to wait until the next calendar year before defense revenue improves?
Michael Hartnett
Well, I think the – my editorial comment was really about aircraft platform readiness was – I mean, that’s probably 20% of the issue. The bigger issue is just the fact that, the normal production delays in making very sophisticated products doesn’t work well with the quarterly metrics.
Daniel Bergeron
And just to touch on top of that Pete our submarine business, didn’t perform to the level that we wanted to in Q2. And so they have shipments moving to the right. So we’re hoping to recover some of that in Q3. But for the whole quarter Aerospace & Defense was $32.6 million. So it’s not like it’s a $100 million segment.
Pete Skibitski
Yeah. Yeah. Understood. Okay. And then just last one for me. What’s your all-in interest rate as of today? I’ve been trending a little lower. So I just want to make sure I had that pegged right.
Robert Sullivan
Sure. So the current moment on the term loan, the rate is the 1-month LIBOR plus a 1.5% spread. So take it poor it is. And then on the bond it’s a fixed 4.375%. And on the dividend it’s — and then the mandatory convertible pays a dividend of 5%.
Pete Skibitski
Okay. Okay. Thank you guys.
Robert Sullivan
If you add those three pieces up along with our interest rate swap, you can see we’re close to 75% fixed on the financing of the Dodge transaction.
Pete Skibitski
Great. Thank you.
Operator
[Operator Instructions] Our next question is from Michael Ciarmoli with Truist Securities. Please proceed.
Peter Osterland
Hey, good morning. This is Pete Osterland on for Mike. Thanks for taking my question. First, I just wanted to ask given some of the supply chain and working capital dynamics discussed and what you’re expecting around free cash flow generation. Could you provide an update on the level of debt paydown that you’re targeting by the end of the fiscal year?
Robert Sullivan
Sure. So if you recall we had said cumulatively starting from last November, we were targeting $400 million by the end of this fiscal year. We’ve paid $270 million through this quarter. So we’re right on track there. And as the working capital loosens up in the back half of the year that’s still what we’re working towards.
Peter Osterland
Okay. Very helpful. Thanks. And then also just — you mentioned labor in your prepared remarks, so I just kind of wanted to dig in there. Just to get a sense of how many net hires do you need to add still? Where are those concentrated? And have there been any difficulties finding qualified workers or any elevated attrition?
Michael Hartnett
Yeah. Well, certainly, we probably have to hire over 100 people. I’m just taking a rough inventory across half a dozen plants. I don’t have a hard number, but it’s probably like 100 on a labor level. Yes, it’s difficult to find the talent. In some areas, the employment rate is unemployment rate is very low. And so we’re scratching pretty hard and doing innovative things in order to build the plants, but we’re making progress. And what was the last part of your question?
Peter Osterland
Just if you were seeing any elevated attrition a you’re kind of…
Michael Hartnett
Not really. We’re not seeing that.
Peter Osterland
Okay. Very helpful. Thanks.
Operator
There are no further questions at this time. I would like to turn the conference back over to Dr. Hartnett for closing comments.
Michael Hartnett
Okay. Well, I think that’s our the status of RBC Bearings today and enjoyed the call enjoyed the questions and look forward to meeting with you again in February. Thanks.
Operator
Thank you. This does conclude today’s conference. You may disconnect your lines at this time and thank you for your participation.
Be the first to comment