Earnings Call Transcript - RBC Q2 2023

Josh Carroll, Investor Relations

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, CEO

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%. In the second quarter of 2023, 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 industrial products was 7.9%, Dodge expanded at a rate of 16.2%. 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 the 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 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 shortfall 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 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 weapons, 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, CFO

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 expenses. 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 were $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.

Joe Ritchie, Analyst

Thank you. Good morning everybody.

Michael Hartnett, CEO

Good morning.

Daniel Bergeron, COO

Good morning.

Robert Sullivan, CFO

Good morning.

Joe Ritchie, Analyst

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, CEO

Yeah. Sure Joe. Well, supply chain continues to be a problem. And it's something that we actually have to work on every day. It continues to impact us in sensitive places. And so we continue to develop countermeasures to reverse its effects. The difficult thing is our materials are not simple materials. They're sophisticated steels, titanium, and aluminum. Sometimes the specifications can be extreme. The lead times on many of these materials have moved out past 50 weeks. So that means your planning horizon extends by another six months when you're trying to plan your plants. We have to make adjustments for that. There's prohibitions on supply from China now on certain defense products that were approved previously. So that makes it more difficult, particularly when there aren't many US suppliers for some of these components. So far it's manageable, but it's difficult. In many cases, the price of these materials has doubled. We have to work on our contracts to ensure that we're passing through the necessary economics to normalize the margins. So it's definitely a challenge, keeping everyone busy, and certainly a reason to get to work early.

Joe Ritchie, Analyst

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, CEO

Well, I think everybody knows what inflation is doing, and that certainly impacts the manufacturing costs of our products. We have to have the right metrics to measure it and ensure that we reflect it in price changes to the marketplace. It's not that we're unique in this; the whole baseline for suppliers changes monthly. This is definitely an area we haven't had to consider so carefully in past years. But one thing about manufacturing products is there are always different problems to solve.

Joe Ritchie, Analyst

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 hope of getting closer to a peak inflation number. Just any thoughts around that would be helpful.

Michael Hartnett, CEO

You mean if the inflation number goes negative then we have...

Joe Ritchie, Analyst

Well, it's a couple of things. No, this is more of a comment around 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 would you have to give back some of that pricing?

Michael Hartnett, CEO

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, Analyst

Okay, understood. Thank you.

Steve Barger, Analyst

Thanks. Good morning.

Robert Sullivan, CFO

Good morning.

Michael Hartnett, CEO

Good morning.

Steve Barger, Analyst

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, CEO

Well, the it's a simple question with a complex answer, Steve, just because of the number of different markets that we're in. All of these markets have their own economic strengths or weaknesses. In many cases, we have long-term agreements with these customers that protect the supply side for us. We look at what their demand outlook is. For example, how many ships does Boeing need to produce in a given month? What's our mix and at what rate should we be running? We roll it all into a business plan. Particularly on the Dodge side of the business, that's driven by the PMI index and other economic indexes, because Dodge is an in-and-out business while RBC historically has contracts and long-term agreements. So you have to be closer to the economy on the Dodge side. Yes, we have models and economic inputs that give us a demand forecast for each product line. Based on this forecasted demand, we decide whether the forecast is valid and adjust the rate at which we should load the plants.

Steve Barger, Analyst

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 growth rates to moderate, or does it still seem pretty robust, as far as you can see?

Michael Hartnett, CEO

Yes. I think for the balance of our fiscal year, I mean, I don't like to get out too far because I prefer not to go beyond the fiscal year, but for the balance of our fiscal year, we expect the industrial businesses to perform in the low double digits.

Steve Barger, Analyst

Organically low double digits. Okay.

Michael Hartnett, CEO

Yes.

Steve Barger, Analyst

Got it. And I know the pace of commercial aerospace has been 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? And I know you don't like to get too far out, but you do have contracts in that business. Just how are you thinking about the back half of 2023 and into 2024 fiscal for you?

Michael Hartnett, CEO

Well, I think the commercial growth rates demonstrated in the second quarter at the OEM level were about 30%. Yes. I think we're going to be living there for a while.

Steve Barger, Analyst

Got it. And so, presumably, you expect the defense side to improve from I think it was down 15 this quarter because of those shipping delays.

Michael Hartnett, CEO

Yes. On the defense side, we produce very complicated, sophisticated products that require various external processing and government approvals. So, it doesn’t all happen in a quarter.

Steve Barger, Analyst

Right. Okay. One more, and I'll jump back in line. The 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, CFO

Let me put it this way for you, Steve. I mean this quarter alone we continued that strategic inventory build of $17 million. We had Dodge costs to stand up their systems kind of pay the TSA. That's close to $10 million. Then we had timing of two significant tax payments coming through. 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. I think we'll start to see that operating cash escalate as we enter the back half of the year.

Steve Barger, Analyst

So, essentially all those things that you just mentioned, I guess you said some of the tax falls in the back half or that was in the second quarter?

Robert Sullivan, CFO

In Q2, we had two payments. In Q3, we'll have one. In Q4, we'll have one. It was the timing that impacted us. The Dodge costs should start to decrease as the TSA goes away in November.

Steve Barger, Analyst

Understood. 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 capital?

Michael Hartnett, CEO

Yes. We're working hard to liquidate some of that inventory build. It's a result of a supply chain mismatch; if you're assembling and you have all your castings but didn't get the seal for the bearing, you can't ship the assembly. So some of these simple things can tie up a lot of working capital.

Steve Barger, Analyst

Understood. Thanks.

Larry Stavitski, Analyst

Hi, guys. How are you? It's actually Larry Stavitski on for Seth today. Thanks for taking my questions.

Michael Hartnett, CEO

Hi, Larry.

Larry Stavitski, Analyst

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, CFO

I think we'll continue to see some strength in the gross margin space. I think Q2 was obviously an exceptionally strong quarter. In the third quarter, with fewer production days, things tend to moderate a bit. The fourth quarter tends to be a stronger quarter for us as well.

Larry Stavitski, Analyst

Okay. But are you thinking – I mean you've been at or above 40% for the last couple of quarters. Is that kind of …

Robert Sullivan, CFO

Yes. I think that's about where we're living these days.

Michael Hartnett, CEO

It's not out of the neighborhood.

Larry Stavitski, Analyst

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 jammed up. Just I guess can you talk about the production dynamics that you're seeing there with COVID and the regional dynamics?

Daniel Bergeron, COO

Yes. Right now, Seth, in Q2 we were back to normal. In Q3, I think we missed about one month, 1.5 months of shipments in Q1. In 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, Analyst

Right. Okay.

Daniel Bergeron, COO

And it was about $6 million this quarter.

Larry Stavitski, Analyst

$6 million this quarter? Okay.

Daniel Bergeron, COO

Yes. It's not a huge contributor to the top line.