Earnings Call Transcript - RBC Q2 2026

Joshua Carroll, Investor Relations

Good morning, and thank you for joining us for RBC Bearings Fiscal Second Quarter 2026 Earnings Call. I'm Josh Carroll from the Investor Relations team. With me on today's call are Dr. Hartnett, Chairman, President, and Chief Executive Officer; Daniel Bergeron, Director, Vice President, and Chief Operating Officer; and Rob Sullivan, Vice President and Chief Financial Officer. As a reminder, some of the statements made today may be forward-looking and are 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 listed in the press release, along with the reconciliation between GAAP and non-GAAP financial information. With that, I'll now turn the call over to Dr. Hartnett.

Mike Hartnett, CEO

Good morning, and thank you. So good morning, everyone, and thank you for joining us. As usual, I'm going to start today's call with a short review of our financial results with some comments, and I'll finish with our outlook on the industry in fiscal 2026. Rob Sullivan will follow me with some more details on the results. Second quarter net sales were $455.3 million, a 14.4% increase over last year, driven by continued strong performance in our Aerospace and Defense segment and steady performance from our industrial businesses. Consolidated gross margin for the quarter was 44.1% versus 43.7% for the same period last year, and adjusted EPS was $2.88 versus $2.29 last year. Clearly, our performance exceeded our expectations for the second quarter of fiscal '26, and the company is showing good momentum moving into the second half of RBC's year. Free cash flow for the period was a strong $71.7 million. 56% of our revenues were from the industrial sector and 44% from Aerospace and Defense, with the Aerospace and Defense sector now racing to parity, we think, next year. Total A&D sales were up 38.8% year-on-year. Commercial aerospace expanded 21.6% and defense expansion was 73.3%. Organically, the performance looks like this: commercial aerospace increased by 21.2% and defense increased by 22.4%. Demand across the A&D sector is impressive, and momentum is strong. Backlog is up to $1.6 billion today from $940 million in March and $860 million last year at this time. We fully expect to approach $2 billion in backlog by year's end, which will be an amazing milestone, especially when you consider that more than half of our revenues preclude backlog production. Although revenues are currently capped by production capacity, we are working hard to expand manufacturing capacities in our marine and aircraft RBC plants, adding more capacity each quarter. Clearly, this will be impactful to margins. Primary drivers here are submarine aircraft and engine customers. Proprietary components are quiet valves and actuators for submarines, that is the Virginia and Columbia boats, as well as MRO supplies for existing fleets. Both Sargent and VACCO are among the RBC contributors here. On airframes and engines, as Boeing, Airbus, and Embraer continue increasing build rates to unprecedented levels, production of our products, of course, must follow. As most of you know, we have substantial content in these airframes and engines, where we supply precision and line bearings as well as integrated structural components across the aircraft and engine spectrum. And with Boeing's recent FAA approval to expand production rates, business is good and about to get better. It's important to understand that building rates of submarines and commercial aircraft are at levels not seen in over a generation since the early 1980s for submarines for reasons both good and bad. We currently are booking some orders for deliveries into the 2030s. RBC is dead center in the middle of this effort today with a considerable number of proprietary sole and single-source products governed by multiyear contracts in the majority of cases. Let's turn over to our industrial business now. Overall, our industrial business was up 0.7%. Industrial distribution was up 3.3%, while the OEM sector was off 4.7%. Continued weakness in the markets of oil, semiconductor machinery and European machine tools continue. Our industrial OEM business is a 70-30 split with 30% being the OEM component. We are encouraged to see the continued demand in the industrial aftermarket across many of the markets that we monitor, including aggregates, metals, grains, food and beverage, and forest products. I'll now turn the call over to Rob Sullivan, who will give some color commentary on the financial treatments and the Q3 outlook.

Robert Sullivan, CFO

Thank you, Mike. As Dr. Hartnett mentioned, this was another strong quarter for RBC. Net sales grew 14.4%, driving a 15.4% increase in gross margin. Gross margins were 44.1% for the quarter or 44.9% on an adjusted basis compared to 43.7% in the same period last year. During the quarter, we delivered strong performance across our business segments, specifically within A&D, which has been seeing strong growth, as Dr. Hartnett previously noted. A&D gross margins during the quarter were 38.7% or 42.3% on an organic basis, and industrial margins were 48.2%. Included in the Aerospace results were $24.7 million of net sales from VACCO during the period, which was acquired on July 18, this quarter. On the SG&A line, we had total costs of $77.4 million or 17% of net sales for the quarter. This ultimately resulted in an adjusted EBITDA of $145.3 million or 31.9% for the quarter. That represents an approximate 17.7% increase in EBITDA dollars compared to last year. Interest expense for the quarter was $13.4 million. This was down 14.1% year-over-year, reflecting the impact of debt payments made over the last 12 months and lower interest rates, partially offset by the impact of borrowing $200 million on the revolver in July to assist in paying for the acquisition of VACCO. During the second quarter, we paid off $45 million on our term loan balance. We made an additional $40 million payment on September 30, which will be reflected in next quarter's results. Diluted earnings per share were $1.90 compared to $1.65 for the same period last year. Adjusted diluted earnings per share were $2.88, representing a 25.8% increase over $2.29 for the same period last year. The tax rate in our adjusted EPS calculation was 22% compared to last year's 22.1%. Free cash flow in the quarter came in at $71.7 million with conversion of 119.5% and compares to $26.8 million and 49.4% last year. The higher conversion rate was due to the increased earnings and working capital management during the quarter. As we have previously noted, our capital allocation strategy going forward will remain focused on deleveraging by using the cash that we are generating to pay off the term loan and then the revolver balance. This week, we finalized an amendment to our credit facility, extending the revolver until 2030. We intend to pay the term loan off by November of 2026. Looking into the third quarter, we are guiding revenues of $454 million to $462 million, representing year-over-year growth of 15.1% to 17.1%. This guidance embeds an operating environment that's been fairly similar to what we have been seeing over the past few quarters with the additional benefit of owning VACCO for a full quarter. On an organic basis, net sales are expected to increase 7.4% to 9.5%. On the margin side, we are projecting adjusted gross margins of 44% to 44.25% for the quarter and SG&A as a percentage of sales to be between 17% and 17.25% for the period. We continue to remain well positioned to achieve our objectives and drive sustainable growth, leveraging our core strengths in engineering excellence, operational efficiency, and innovative product development. Looking ahead, our focus will remain squarely on executing on our organic growth strategy, further integrating VACCO, driving operational efficiencies, and delivering strong free cash flow conversion that will create long-term value for all our stakeholders. With that, operator, please open the call for Q&A.

Operator, Operator

Our first question is from Kristine Liwag with Morgan Stanley.

Kristine Liwag, Analyst

Can you provide some insights on the backlog growth of 60% in the quarter? Specifically, how much of that growth can be attributed to the VACCO acquisition, and what were the main factors driving that increase? You also mentioned a $2 billion backlog by the end of the fiscal year, which represents a significant increase from the current level. Any additional information on what you are observing in this context would be appreciated.

Robert Sullivan, CFO

Yes. So approximately $500 million of that increase is due to the VACCO acquisition. And then the remainder of the business is up more than 20% from this time last year. We're seeing extraordinarily strong growth in the A&D side of the business. Approximately 90% plus of our backlog is really all A&D. The industrial side has a much smaller component when you look at our backlog, and we expect that to continue through the rest of the year.

Mike Hartnett, CEO

Yes, Kristine, we're currently negotiating contracts, and we're very far along. They're very mature in the negotiations, and we expect to conclude those within the month, which should kind of round the whole thing up to that $2 billion level, at least around that figure. Maybe it's $100 million less, maybe it's $100 million more, something like that. But it's to some extent, we've had rollover of aircraft contracts, which all begin sort of next year. And there are still several marine contracts that we're working our way through and really, for the most part, have worked our way through it, and we're waiting for the conclusion of the signatures.

Kristine Liwag, Analyst

Great. Super helpful. And then I think Dr. Hartnett, last time when we talked, it seems like Boeing production rates are starting to move up to the right. And from Boeing's earnings this quarter, it seems like that's really truly materializing. Can you just remind us regarding your production rates? What's the utilization of your aerospace plants? And when we think about this volume finally coming through, how should we think about incremental operating margins, especially with the changes in the contract that you've had and of course, the inflation that's gone through the business in the past few years?

Mike Hartnett, CEO

Well, I mean, right now, in terms of capacity utilization for the airframe business, we're pretty much at 100% everywhere. We're adding capacity; we're adding shifts; we're adding manpower; and we're adding some capital to continue. We're stepping up capacity every quarter going forward in several of the plants. Demand is strong. You're going to see, obviously, when you add shifts, you get better absorption of the overheads. And so you get some margin expansion there. So the outlook for margin expansion overall is incredibly positive.

Kristine Liwag, Analyst

Yes, that's very exciting to hear.

Operator, Operator

The next question is from the line of Michael Ciarmoli, with Truist Securities.

Michael Ciarmoli, Analyst

Nice results. Maybe just housekeeping. I think I may have missed it, Rob. What was the Aero OEM growth in the quarter and the Aero distribution growth in the quarter?

Robert Sullivan, CFO

So, are you referring to the commercial aspect of the Aero OEM or the entire segment?

Michael Ciarmoli, Analyst

Just commercial. Sorry.

Robert Sullivan, CFO

So commercial OEM grew 27.9% this quarter. And commercial distribution was basically flat. It's actually down 2%, but more or less flat.

Michael Ciarmoli, Analyst

Okay, I understand. Looking at industrial distribution, it seems it was up 3.3%, but down 8% from the previous quarter. Is there anything specific going on? Was it related to seasonality or lumpy orders? I know it's typically down a bit sequentially due to seasonal factors. Is there anything noteworthy on the industrial distribution side?

Robert Sullivan, CFO

We had some really relatively strong performance in the industrial distribution business in the first quarter, with some really strong orders on that end. So the fact is it's still growing. It's just probably quarter-over-quarter, and that's what you're seeing there.

Michael Ciarmoli, Analyst

Okay. Got it. You mentioned that the dilution from VACCO is around 360 basis points. Can you provide some insight into how we should view the potential for VACCO's margins to improve? I know you suggested a positive outlook for margin expansion in response to Kristine's question, but how should we consider the diminishing impact of VACCO and the prospects for those margins aligning with historic RBC margins?

Robert Sullivan, CFO

Yes. So look, they're running in the mid-20s at this point on an adjusted basis, that's their normal run rate. It's going to take some time, but we think there's tremendous capacity for some operational synergy there over time to get those margins looking like the rest of the RBC business. That's what we picked up on when we were doing diligence. And that's kind of the internal objectives. But these projects do take time.

Mike Hartnett, CEO

Yes, Michael, I would say that regarding VACCO, we are still in the initial phase of our relationship and are very encouraged by what we see. There are numerous manufacturing synergies with our Southern California plants, which is critical because VACCO needs to significantly boost production rates. The manufacturing production will occur in the West Coast plants that have adequate floor space, and they will require additional capacity. We are currently working on this, which will positively impact margin absorption on the West Coast. Additionally, we are reviewing existing space contracts and renegotiating terms to align better with RBC policies. We are addressing this one step at a time as part of the overall process. We anticipate that next year, VACCO will emerge as a key player in our lineup.

Operator, Operator

The next question is from the line of Steve Barger with KeyBanc Capital Markets.

Steve Barger, Analyst

You talked about adding capacity to support all these aerospace and defense programs. And I'm sure planning for that growth is a moving target, but what revenue level did you direct the team to plan for?

Mike Hartnett, CEO

For that group?

Steve Barger, Analyst

For yes, let's start with A&D and then maybe talk about the whole company.

Mike Hartnett, CEO

Why don't we just email you our 5-year business plan, Steve?

Steve Barger, Analyst

Well, you're talking about needing to substantially ramp production across multiple programs. I'm just wondering, do you think that you need to be able to support $1.2 billion, $1.5 billion? I'm just talking A&D now. Or is this going to be a $3 billion capacity plan? Or is this going to be a situation where you're just continually kind of tacking it on and chasing that capacity as those programs evolve?

Mike Hartnett, CEO

That's a great question. We're assessing this on a business-by-business basis, and I haven't consolidated the final figures yet. Much of this hinges on how swiftly we can increase capacity and enhance throughput. For example, Sargent's marine division was generating around mid-30s in annual revenue from that marine program two years ago. We aim to exceed $100 million as soon as possible, and the pace at which we reach that goal is important. This is part of what's happening in Tucson. Regarding VACCO, we're still determining the steady-state production rate necessary to satisfy the MRO business and shipbuilders with the hardware output. There are differing opinions on what that figure should be right now, so I can't provide specific details, but it's significantly higher than the current levels. We expect considerable growth in airframe, air engine, and marine sectors over the next few years. It's almost inevitable if they continue to build airplanes and submarines.

Steve Barger, Analyst

Right. No, I guess that's the key takeaway here is that RBC has the potential to have a pretty significant top plan based on the fleet of opportunity you see in front of you.

Mike Hartnett, CEO

Correct. That's how we see it.

Steve Barger, Analyst

And when you look at those programs and opportunities out there, do you have enough engineering staff to support underwater ground-based aircraft space? Like is that a capacity constraint as well on the engineering side?

Mike Hartnett, CEO

Well, you never have enough engineers, and you certainly never have enough good engineers. I don't think it's a capacity constraint. The design engineering work and the testing engineering work for the most part is done. There's probably incremental staff increases needed, although when we acquired VACCO, we got quite a few very capable engineering team members. So that's going to be helpful. I think on the production side, we have our MET program where we hire college engineering graduates every year and put them into our plants in a 2-year training program. We've been doing this for years, and I think the last time I looked at the numbers, the number of people in the 2-year training program was probably 100 folks. We've been salting engineering talent into the company for years. We have a very deep bench of expertise. We're actually looking at that yesterday at who's in the 10- to 15-year group with us because that's the emerging management of the company, and it's quite solid.

Steve Barger, Analyst

That's good to hear. I don't remember ever hearing an AI-related question on one of your earnings calls, so I'm happy to be first. Are you leaning into AI from the engineering side or anywhere else in the organization to try and help optimize manufacturing or engineering or anything else?

Mike Hartnett, CEO

I think AI is something that is almost unavoidable. You get a lot of useful answers quickly from platforms like Chat or Grok. Personally, I ask my five questions every day. I haven't subscribed to ChatGPT, but they provide me with answers for those five questions daily, and I make use of them. Many of us subscribe and find it helpful. It is definitely making an impact, although we don't have a clear understanding of its exact effects yet. Recently, we were discussing a component that wasn't passing our tests. I asked AI about the tribological coupling of beryllium copper with steel and how to enhance that coupling through design. Within 30 seconds, I received a report that would typically take a week to obtain from one of my engineering teams, and it was excellent. We even considered using some of those recommendations within the hour. That illustrates the impact it is having here.

Steve Barger, Analyst

That's interesting detail.

Operator, Operator

Our next question is from the line of Scott Deuschle with Deutsche Bank.

Scott Deuschle, Analyst

Rob, when you restrike the Boeing and Airbus contracts, do we see the full benefit of that hit in the calendar first quarter? Or do you have to honor some pre-existing backlog ordered at lower prices such that it takes a few quarters for that benefit to show up in gross margins?

Robert Sullivan, CFO

We should see most, if not all of that, right away on the shipments that start after January 1.

Scott Deuschle, Analyst

Okay. And in terms of what you all have been targeting to get out of those renegotiations, are you generally tracking to what you hoped for in terms of your ask? Or is there any just general update as it relates to the status of those negotiations you can offer?

Mike Hartnett, CEO

Well, you never get what you ask. The airframe people are very tough negotiators. Let’s just put it this way. We negotiated with them for 2 solid years. That negotiation was scheduled every week for 2 solid years.

Scott Deuschle, Analyst

Got it. Okay. Go ahead.

Mike Hartnett, CEO

We were reasonably satisfied; I think neither side was completely happy with the results, but we weren't disappointed.

Scott Deuschle, Analyst

Okay. And then just following up on the prior question on AI. Caterpillar reported results earlier this week. They have an Investor Day next week. A big topic of conversation is the demand on the smaller and midsized power generators. I don't think on the large combined cycle generators, you have much content. Correct me if I'm wrong. But on the smaller and midsized reciprocating engines, is that at all an area that RBC plays in?

Mike Hartnett, CEO

No, we're not in that area at all.

Scott Deuschle, Analyst

Okay. And then last question for you, Dr. Hartnett. There's now a publicly traded company out there that's generating 30% EBITDA margins in their fasteners business. And the industry appears to have some supply constraints. I believe you'll have some capabilities here. You got through Sargent and shear pin. So just curious, is that an area of strategic interest for you as you think about organic investment in the business, just given the margin potential others in the industry are demonstrating?

Mike Hartnett, CEO

We've looked at fasteners many times. Yes, we have a business that sort of overlaps that market. We don't see it as a productive market in terms of proprietary protection, and what our current capitalization allows us to produce is let's put it this way: There's more interesting markets that we pursued.

Operator, Operator

The next questions are from the line of Pete Skibitski with Alembic Global.

Peter Skibitski, Analyst

Nice quarter. In defense, just with this government shutdown, we're about a month into your third quarter. Just wondering if you guys are seeing any headwinds on order flow from the shutdown.

Mike Hartnett, CEO

None, none.

Peter Skibitski, Analyst

None. Subs are pretty protected. Okay. And then just on the 777X delay shift to the right, Mike, I know you guys have a lot of content there. Any meaningful impact to your prior plan over the next few quarters from that delay?

Mike Hartnett, CEO

No, it hasn't been part of our plan at all due to the uncertainty surrounding when that ship is going to be produced. If it's produced sooner, we would consider that as a form of plan insurance.

Peter Skibitski, Analyst

Okay. Last one for me, just on, Mike, your bullish comments earlier about gross margin expansion. Are you still within the framework of the kind of your typical 50 to 100 basis point annual goal? Or are you moving kind of beyond that organically and/or with the VACCO opportunity there? What's the right way to think about that?

Robert Sullivan, CFO

Well, we ended last year at about 44.4% for the full year. Our first 2 quarters this year, 45.4% and 44.9%. Obviously, VACCO is a little bit lower than the rest. So that will impact the second half of the year to a certain degree. But organically, we're right in line with that level of expansion. Even with VACCO, I think we're still going to be able to expand our margins year-over-year. So I think we're very pleased with where we are.

Operator, Operator

Our next question comes from the line of Ronald Epstein with Bank of America.

Ronald Epstein, Analyst

Has there been any impact from critical minerals, rare earths on what you guys do? And if there is, how are you mitigating it?

Mike Hartnett, CEO

No, we see no impact at all. I think our products don't use it. We saw more of an impact from the availability of the more exotic stainless steels, which that problem seems to have corrected itself, but that was a problem 12 months ago, and it was a bigger issue then.

Ronald Epstein, Analyst

Got you. All right. Good to know. If I could follow up on that AI question, I found your answer fascinating as an engineer. How do you review the information from Grok or similar sources to actually trust it? Once you reach a point of trust, does this affect the number of engineers you will need? How do you gain confidence that the AI is providing useful information?

Mike Hartnett, CEO

I think when we received the answer regarding the tribological coupling, it provided us with suggestions that aligned with our own thoughts. It served as a reminder that there are several ways to approach improvements, and it prompted us to consider options we were already familiar with. This experience helped focus our discussions and encouraged our thinking on the topic. This is how we are currently utilizing AI.

Ronald Epstein, Analyst

Yes. It's intriguing to consider a scenario where it's capable of achieving even more for you. Or is this simply the way things are?

Mike Hartnett, CEO

Yes. It's amusing because during our operations meetings, we sometimes have about 30 people present, and there's often a discussion on how to tackle various problems. Everyone is looking to AI for suggestions and suddenly there are ideas on the table that you might not have considered or thought of so quickly. The days of driving to the university to use the library are long gone.

Operator, Operator

Our next question is a follow-up from the line of Kristine Liwag with Morgan Stanley.

Kristine Liwag, Analyst

I mean, I guess with that comment, Dr. Hartnett, it sounds like you should pay for ChatGPT and just stop doing the free stuff for now.

Mike Hartnett, CEO

Well, I guess I tipped you off on how we manage expenses at RBC.

Kristine Liwag, Analyst

Well, great. So with that, I think there are some interesting themes emerging around AI and the concept of embodied AI. I wanted to ask you a different question that we haven't really discussed before. What are your thoughts on humanoids? We're starting to see some fascinating machines, and bearings in machines are similar to elbows and joints in humans. How do you view that space? Do you consider that a commoditized bearing, or do you believe you have a role in that area?

Mike Hartnett, CEO

Well, I think if you've been through some of our plants, there's a healthy amount of robotics that are co-robots working beside a person who's doing work, right? As that technology proves itself, we will adopt it. There's no question about it. Ultimately, there'll be humanoids in the RBC plants doing what, I'm not sure. But it will show up as a capital requisition at one of our ops meetings in the not-too-distant future, and that's how it will begin. Right now, we’re using robotic and non-contact measurement technologies.

Kristine Liwag, Analyst

I see. Super helpful. So you see yourself more as a user. But I guess my question is more as a supplier to that industry, similar to as you're a supplier for a lot of those robotic systems. Is this a potential business opportunity for you as a supplier if that industry matures? Because I can imagine if you are using it for those kinds of industrial use cases, then quality and making sure the humanoid doesn't break down is going to be similar to the value that you add for other industrial applications where you're a small dollar amount, but a critical portion for functionality.

Mike Hartnett, CEO

Yes. I think today, we supply bearings for robotics that are in some pretty sophisticated applications where there's high temperature or vacuum or both producing computer chips. The way this always starts is somebody designing a robot doesn't have any production volume, and they'll go to one of our distributors and buy one of our bearings to use in their prototype. Once it proves out, and they start getting into production, they'll continue to use that distributor until production gets to a certain rate and then they'll trace back to the manufacturer or we'll find out about it from our distributor that this is an OEM using considerable amounts of volume. That's how every one of these markets is developed.

Kristine Liwag, Analyst

And do you see this as an exciting market?

Mike Hartnett, CEO

I really haven't thought that much about it. I think Elon Musk thinks it's an exciting market because he thinks cars are less exciting, right? So he's going to turn Tesla into a humanoid robot machine. I guess that works.

Kristine Liwag, Analyst

Great. Maybe we'll spend another time talking more about that.

Operator, Operator

At this time, we've reached the end of our question-and-answer session. I'll turn the floor back to management for closing remarks.

Mike Hartnett, CEO

Okay. Well, I think that ends our conference call for today. I want to thank everybody for their participation. Our job now is to go back to work and make the third quarter happen. So thanks again.

Operator, Operator

Thank you. This will conclude today's conference. You may disconnect your lines at this time. We thank you for your participation, and have a wonderful day.