RBC Bearings INC (RBC) Q1 2024 Earnings Call Transcript

Greetings, and welcome to RBC Bearings’ Fiscal 2024 First Quarter Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to Josh Carroll with Investor Relations. Please go ahead.

Good morning and thank you for joining us for RBC Bearings fiscal 2024 first quarter earnings conference call. With me on the call today are Dr. Michael Hartnett, Chairman, President, and Chief Executive Officer; Daniel 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.

Thank you, Josh, and good morning to all, and welcome to the RBC conference call. I’m pleased to report that our net sales for the first quarter of 2024 were $387 million. This represents an increase of 9.3% from last year. For the first quarter of 2024, sales of industrial products represented 69% of our net sales with aerospace products at 31%. Over the past ten years, revenue growth at RBC has been made at a compounded rate of 14.7%. Gross margin for the quarter is $167.9 million or 43.4% of net sales. This compares to $141.2 million or 39.9% for the same period last year, a 350 basis point improvement from last year. We are tremendously pleased with the gross margin expansion, which is clearly a result of increased volumes in our aerospace product plans, coupled with the impact of many components of synergy achievement from the Dodge acquisition. Given this trajectory, we can report that we plan to finish the year with gross margins in the low to mid-40% range. I want to take a moment here and thank the RBC teams for their excellence and execution, both in the plants and the offices, as well as the top grades received for customer satisfaction. It is your attention to detail that makes the difference and creates a strong preference for the RBC and Dodge branded products in the aircraft and industrial markets. Thank you all for a job well done. Adjusted operating income for the period was $85.3 million or 22% of net sales compared to last year of $68.3 million and 19.3% respectively, a 25% improvement. Free cash flow was a strong $55 million. This has allowed us to reduce debt by over $450 million since the acquisition of Dodge in November of 2021. We now have achieved a net debt to EBITDA ratio of 2.84 over trailing 12 months, down from 5.65 from fiscal 2022. RBC has grown EBITDA at a compounded rate of 15.2% per year over the last ten years. Adjusted EPS was $2.13 a share, a 19% improvement from last year. Adjusted EBITDA was $120.4 million, 31% of net sales compared to $100.7 million and 28.4% of net sales for the same period, a 20% increase. Overall, we are encouraged by the cultural fit now that exists between Dodge and RBC, and the environment of teamwork and camaraderie that has developed over the first 18 months since the acquisition, more importantly, the future that this coupling has created. We look forward to finishing the year at about $1.6 billion in revenue. Regarding the industrial business, during the period, the industrial sector growth was 4.7% against some strong comps last year. Last year, improved supply chain performance allowed shipments of late orders to customers, creating a Q1, Q2 and 2023 sales bolt, which is behind us now. Dodge was a revenue leader in the industrial sector with a 9.4% expansion on combined OEM and distribution sales. Several of our target market sectors expanded at a double-digit rate over the period. These include oil and gas, food and beverage, and forest products. We expect this to continue for the balance of the year, driven by world events. In aerospace and defense overall, we saw an expansion rate of 21.2% with commercial aero OEM up 26.5% and commercial distribution up 35.9%. Defense was up 7.9%. OEM defense was up 11%. Jets, missiles, helicopters, and marine were the drivers. Aftermarket was down 3.3%, mainly fighter jets. We have finally shaken off the nightmares of the pandemic and the continuing endemic problems of the major builders. The demand drivers, as explained in past calls, now are the large plane builders and their supply chain in support of the production of Boeing and Airbus 787, 737 and A330 planes. Currently, we are building 737 materials at a rate of 38 per month, with new orders inbound at a rate of 42. On the 787, our current build rate numbers are three per month. We expect that order rate very soon, it is probably a little past due. As is typical of these products today, RBC generates 70% of its sales from sole source or single source positions. In summary, let’s go over the highlight reel. Q1 sales were up 9.3% for the period, EBITDA $120.4 up 19.5%, adjusted net income of $2.13 up 19%, full-year guidance revenues $1.6 billion, gross margins expected to be in the low to mid-40s, debt pay down since November 2021 of $450 million, trailing EBITDA to net debt today is 2.84 from 5.65 in fiscal 2022, 70% of our revenues under replaced products consumed in use. We are normally the number one market share supplier of our products, and 70% of our business is either sole source or we are the primary source for the product. Another point to mention is our backlog numbers; they are not particularly relevant. Probably 75% of our revenues never pass through our backlog. The aircraft business is done on a, where orders are received from a computer screen and shipped as received. Dodge is working normally when they have a very small backlog, if any, and shipments are made subject to orders received. For the most part, it is a day or two within the receipt of that order. Regarding our second quarter of 2024, we expect sales to be somewhere between $380 million and $390 million range. I will now turn the call over to Rob for more detail on the financial performance.

Thank you, Mike. SG&A for the first quarter of fiscal 2024 was $64.7 million compared to $55.8 million for the same period last year. As a percentage of net sales, SG&A was 16.7% for the first quarter of fiscal 2024 compared to 15.8% for the same period last year. Other operating expenses for the first quarter of fiscal 2024 totaled $18.2 million compared to $20.9 million for the same period last year. For the first quarter of fiscal 2024, other operating expenses included $17.5 million of amortization of intangible assets, $0.3 million of restructuring costs associated with our California operations, and $0.4 million of other items. For the first quarter of fiscal 2023, other operating expenses consisted primarily of $17.3 million of amortization of intangible assets and $3.8 million of costs associated with the Dodge acquisition, partially offset by $0.2 million of other income. Operating income was $85 million for the first quarter of fiscal 2024 compared to operating income of $64.5 million for the same period last year. Excluding approximately $0.3 million of restructuring costs, adjusted operating income was $85.3 million or 22% of sales for the first quarter of fiscal 2024 excluding approximately $3.8 million of acquisition costs. Adjusted operating income for the first quarter of fiscal 2023 was $68.3 million or 19.3% of sales. Interest expense for the first quarter of fiscal 2024 was $20.5 million compared to $15.8 million for the same period last year. For the first quarter of fiscal 2024, the company reported net income of $50 million compared to $37.4 million for the same period last year. On an adjusted basis, net income was $67.7 million for the first quarter of fiscal 2024, compared to $57.5 million for the same period last year. Net income attributable to common stockholders for the first quarter of fiscal 2024 was $44.3 million compared to $31.7 million for the same period last year. On an adjusted basis, net income attributable to common stockholders for the first quarter of fiscal 2024 was $61.9 million compared to $51.8 million for the same period last year. Diluted earnings per share attributable to common stockholders was $1.52 per share for the first quarter of fiscal 2024 compared to $1.09 per share for the same period last year. On an adjusted basis, diluted EPS attributable to common stockholders for the first quarter of fiscal 2024 was $2.13 per share compared to $1.79 per share for the same period last year. Turning to cash flow: the company generated $61.7 million in cash from operating activities in the first quarter of fiscal 2024, compared to $59 million for the same period last year. Capital expenditures were $6.7 million in the first quarter of fiscal 2024 compared to $7.9 million of capital expenditures for the same period last year. We paid down $50 million on the term loan during the period, leaving total debt of $1.34 billion as of July 1st, 2023, and cash on hand was $56.7 million. Our net debt to adjusted EBITDA for the trailing 12 months is 2.84, compared to 3.06 at the end of fiscal 2023 and 5.65 at the end of fiscal 2022. I would now like to turn the call back to the operator for the question-and-answer session.

Thank you. Our first questions come from the line of Kristine Liwag with Morgan Stanley. Please proceed with your questions.

Good morning, guys. On the margin that you printed this quarter, I mean, it is just a monster margin. My first question is, in hindsight, like, being able to generate margins at 43.4% gross margin within almost two years of ownership of Dodge. In hindsight, were you really surprised? Were you surprised that you achieved this much margin expansion in such a short period? Can you give some color in terms of where that surprise could have potentially come from? I mean, this is a pretty meaningful change in profitability in such a short amount of time for a company that is becoming larger like yours?

Sure. Let's put it this way. Kristine, we are pleased with the margin expansion that we have been able to achieve with the Dodge RBC combination since November of 2021. Are we a little ahead of our plan? I would say we are. Is there any one thing that we did to achieve that kind of performance? There is never one thing that you can do. I mean, there is a series of things that have to be done in terms of how to tune up the performance of a business. Certainly, looking at the price cost of your 80/20 items is really important to do right out of the gate. Trying to understand if you have a large revenue producer that has a smaller margin than it should have or that is acceptable, what to do about it. You have a lot of smart people in the system with good ideas on how to correct things like that. You have many meetings with many people on product line by product line to discuss what can be done in terms of operational performance, what costs should be passed along to the marketplace because you have experienced steep material charges from suppliers over the years that were not passed along. You have to determine if that product offered for sale is something you should even be offering. Some products linger when they should die. There is a certain coloring effect, and that imbalance improves the mix. Another aspect to consider is that the entire customer base has various discounts associated with how they buy the product. Often those discounts haven’t been revisited in a decade. So revisiting those discounts is another important part of the process. Finally, having additional volumes going through our aircraft plants that have been sort of on standby since 2019 is extraordinarily helpful. So there are several components that are working together for us right now that are very positive, and we are on a very good path.

You mentioned that backlog isn’t a great read-through for the business now, especially with the book to ship aspect of the portfolio. So first, what have you had to do differently, if any, to be able to forecast demand and get your demand signals to your planning in your factory? Secondly, how accurate has your methodology been in hindsight?

Well, there are kind of two answers to that. For the bulk of our business that is aircraft, it is pretty easy to understand what you should be building and having available for immediate delivery based upon your contracts and Boeing or Airbus or Cessna’s build rate. You stay close to the build rate, understand your bill of materials for that particular airframe, and what you are obligated to in terms of a statement of work. If you revisit that monthly and ensure that you have materials inbound and that you have the right load against your plants so the product is available when needed, that is really the way that we got supplier of the year at Boeing. When you look at Dodge, Dodge is a little different. They depend upon doing a great job forecasting the demand in their market sectors. Over the years, they have independently developed a process of being able to forecast the economics of a given market sector, translating that down to build rates for items sold to that sector. When I first saw their methods, I was skeptical about its feasibility, but they do an amazing job satisfying their customer base and ensuring that the right product is available at the right time. A visit to one of our plants will show you how a plant with 10,000 line items makes every line item available every day for shipment to a customer with sort of minimal backup in inventory. It is really an experience to see how they do that.

In terms of your different end markets, can you provide the trends you are seeing and where you see risks and opportunities regarding your full-year outlook?

Yes. Are we talking industrial, aircraft defense, or all three?

All of the above, please.

Aircraft is, unless something different happens, we are pretty much dialed in on rate, materials, plant loading, and staffing. We know what the program is, and by the end of this year, we will be running hard to keep up. That is how it looks. The defense side, the marine business is one of the leaders in our defense program, and we are busy building submarine components to service the Navy. That is the number one defense priority: building submarines, and we are a big supplier in that category. Our contracts are multi-year, multi-products, multi-million dollars, and they are in place. Our supply chain is working effectively, and things are starting to move through the plant just as we like to see. We expect to see good growth in that sector for the rest of the year. On the industrial side, there are several important markets for us, and we have been studying this to understand which markets are truly material to us and have substantial growth potential. We see substantial growth potential based on demonstrated consumption of our products in key markets: food and beverage, forest products, oil and gas, mining and aggregates. These are material markets for us that demonstrate double-digit growth potential or have external factors, like the Infrastructure Bill, encouraging that potential.

Our next questions come from the line of Peter Skibitski with Alembic Global. Please proceed with your questions.

Good morning, guys. Nice quarter. Just one follow-up on gross margin. It sounds like performance is a big part of the great result there. Just curious, Mike, because I know you have talked about pricing power being a tailwind for you due to inflation. On a relative basis, how much was pricing helpful to the gross margin result?

Pete, I never broke that out. I do know that many of our businesses, particularly Dodge, are supply chain dependent. We saw substantial price increases from our supply chain for materials, and I know the pricing we put through to the marketplace, to the best of our ability, was at least neutralizing what we saw for material increases.

Shifting to SG&A, you guys are running around 15-ish percentage of sales last year in SG&A and you are at 16.7% here in the first quarter, guiding into the 60s in the second. It just seems like something kind of flipped here on SG&A. Could you give us some color on what has been going on and if that is expected to continue through the midterm?

Yes. What we are seeing through SG&A is an investment in organic growth throughout the various cost centers. We should see some leverage on that as we enter the second half of the year. But in terms of what falls down to the operating income EBITDA line, if you look at adjusted EBITDA quarter-over-quarter, even versus Q4, you are seeing a 40 basis points increase. So it is not all getting caught up in SG&A; it is flowing down.

Last one for me. Why did you decide for the first time to give full-year revenue guidance? Just curious about your thinking there. Are we still expecting double-digit growth at A&D, netting out mid-single-digits or so at industrial? Is that kind of the way you are thinking?

Yes, that is the way we are thinking. Every year we get into this situation where our second and third quarters are typically weak quarters for us because of the number of days, vacations, holidays, and so forth. We end up explaining that to everybody ad nauseam. So we thought it would be better just to say, relax, the full-year looks healthy. We have two quarters that are typically weak, and we know that, and we expect to have a powerful fourth quarter bringing us to those kinds of numbers. We just wanted to take a more offensive position on explaining how the year lays out.

Our next question comes from the line of Steve Barger with KeyBanc Capital Markets.

I have a gross margin question too. Mike, for the year, you said low to mid-40% range, which is incredible because that includes 44% or 45%, which would be a huge win relative to 43.4 this quarter. Can you talk about what the upper limit is when you say low to mid-40%?

I’m going to let Rob do that because he is always pulling on my collar.

Look Steve, I mean, if you look even versus where we were at the end of Q4 and now where we are in Q1, we are seeing some significant step-up in gross margin. We feel 43% is a comfortable spot for us at this point. Obviously, you have seen our playbook, and we will continue to push the limits where we can. But that is why we are saying low to mid at this point.

I know segment margins come in the queue, but with a 52% incremental operating margin this quarter, one or both of the segments must have been exceptional. Can you tell us which was the real outlier?

Yes, you will see industrial gross margins were about 45% this quarter, so we haven’t even seen the full benefit of what aerospace is going to bring to the table as those plans start to push even higher.

Another bearing company this week took guidance down, saying its industrial distribution and off-highway customers are destocking, even though they think that underlying demand will stay positive. Are you seeing any similar issues across the Dodge portfolio? Do you expect the industrial segment will remain positive from a growth standpoint each quarter this year?

I anticipated that question. After reading through the transcripts of the other bearing companies, I thought we should investigate the destocking issue ourselves internally because I haven’t heard much about it. Normally, I would hear a few panic calls if that were occurring. We don’t see that happening. Last year the supply chain was still fragile, and people were worried about getting the products needed to run their plants, leading to panic buying. We had a backlog of many tens of millions of dollars that were shipped as soon as we took the order, it was late. We didn’t have the product available for shipment because it hadn’t been produced, but we had those orders. This year, the panic buying is reduced, and people have more confidence in their supply chain performance. We don’t see any panic buying anymore; things are definitely back to normal.

Are you happy with your own inventory position relative to the demand you see across both aerospace and industrial?

Yes, we are. Actually, I think we have a little too much inventory and we are trying to bleed that down. We got caught up in the supply chain issue where too much material came in because we had to go to several sources, and then they all solved their problems and sent it in. We will be reducing inventory for the most part this year, particularly in the industrial businesses. The aircraft business, on the contrary, has lead times extending from the normal 40-week material lead time to now 60 weeks, and even possibly more than 70 weeks. We are taking a more aggressive position to bring in safety stock of key materials to ensure that we don’t disappoint our customers.

Our next questions come from the line of Michael Ciarmoli with Truist. Please proceed with your questions.

Good morning, guys. Nice results and gross margins. I think I missed it, but what was the year-over-year growth rate for industrial OEM and distribution if you have that?

So industrial OEM was down 9.2% year-over-year, and industrial distribution was up 12.7%.

Got it. Perfect. Back to the margins, did you have substantial contracts or pricing flow through, or did anything change quarter-to-quarter? It simply seems surprising to get this gross margin leverage on weaker sales sequentially. Anything that jumped out recently?

To go through my list of the obvious, certainly, we talked about the volumes in the aircraft businesses that are going to help us more and more throughout the year. Secondly, we have several processes that we were working on in 2019 and right before the pandemic. The two to three years while volume demands were off allowed us to mature those processes, which has been helpful. We also insourced components over the period that accrued to the benefit of the margin.

On the in-sourcing, what inning are you in there? I know you had mentioned at one point about $200 million of savings, so it sounds like you are starting to see some of that benefit?

There is a pool of $200 million plus to choose from. Not all fits, but some does.

Last one on the year: are you still projecting double-digit aerospace revenue growth and high single digits for industrial as part of that $1.6 billion?

That math works. Industrial's goal has always been to grow two times GDP, and I think that fits.

Our next questions come from the line of Joe Ritchie with Goldman Sachs.

This is Vivek Srivastava on for Joe. I wanted to zoom in on the industrial side, particularly the classic RBC industrial. Looks like sales declined mid-single-digit in the classic RBC industrial part. Can you provide any color on what drove the decline? How does that growth in the classic business look going forward in the coming quarters?

On the industrial cyber classic RBC OEM site, it was driven by semiconductors, wind machine tool holders, and warehouse-related issues. We just had a really hard comp to last year, but we anticipate some of these markets will improve in the second half of the year.

Looking at next quarter's guidance, the low end of the sales range would suggest industrial probably decelerates. Can you clarify what underpins the low-end estimate, especially on the industrial side?

When we assess how many production days are available in the quarter compared to the first quarter, there are fewer production days, affecting both the industrial and aerospace defense sides of the business. It depends on the big projects we are shipping on, such as the F-35 project, which can be variable. We have a similar impact in Q3 due to the holiday season. In Q4, we will gain five to seven production days, allowing for shipping an extra five to seven days of product. When things normalize year-over-year, we typically see a U-shaped effect. But now that Dodge is integrated for a year, we go back to our typical routine with seasonality driven by production days.

What green shoots are aiding your industrial business right now, both in the present environment and the upcoming two to three quarters?

We have witnessed quarter-over-quarter growth in some of our markets such as food and beverage, forest products, oil and gas, mining, and aggregates. These are all strong markets for us. We need to align our sales resources with these markets to capitalize on their growth, which requires some organizational adjustments. In the oil and gas area, we are almost at capacity in manufacturing to service that market, and we are working to add capacity, which generally takes some time because of the machinery involved. We expect additional capacity to be online for that business by late fourth quarter.

I’ll add one more item. For example, in 2021, we shipped around $4 million of product into the space industry. Last year, we shipped $10 million, and just in the first quarter of this year, we already shipped $4 million. This is a significant growth area for us with participation from about 15 different RBC facilities.

Our next questions come from the line of a representative with Bank of America.

With the step-up coming for aerospace OEM production rates, can you provide more details on ship set value or any increased content expected?

We don’t publish our ship set content, but we are picking up market share on different platforms on both the commercial and defense side. Our significant contracts include the 737, 787, 777X, F-35, and we also have major content on our marine programs under Virginia and Columbia submarines for Newport News and Electric Boat.

Our next questions come from the line of Kristine Liwag with Morgan Stanley. Please proceed with your questions.

Thanks for letting me back in. After almost two years of integration with Dodge, what is your appetite to restart the M&A pipeline? Historically, you wanted to maintain a 50-50 balance between aerospace defense and industrials. What is your appetite today, and what does the pipeline look like?

With those ratios improving significantly, our appetite for acquisitions in aerospace defense is strong, and we are actively evaluating potential partners. That entire process is starting over again now.

Ladies and gentlemen, there are no further questions at this time. I would now like to turn the call back over to Dr. Hartnett for any closing remarks.

Thank you, and I appreciate all the discussions today on RBC. I hope we have had a chance to explain our business a little bit better and share what the future looks like. We will speak again in November. Good day.

Thank you. That does conclude today’s teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.